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The Causes of the Economic Crisis 

And Other Essays Before and After the Great Depression 

Edited by Percy L. Greaves, Jr. 

The Causes of the 
Economic Crisis 

And Other Essays Before 
and After the Great Depression 

Ludwig von Mises 

The Ludwig von Mises Institute 
dedicates this volume to all of its generous donors 
and wishes to thank these Patrons, in particular: 

Reed W. Mower 

Hugh E. Ledbetter; MAN Financial Australia; 
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The Causes of the 
Economic Crisis 

And Other Essays Before 
and After the Great Depression 

Ludwig von Mises 

Edited by Percy L. C reaves, Jr. 

von Mises 


On the Manipulation of Money and Credit © 1978 by Liberty Fund, Inc. 
Reprinted by permission. 

Originally published as On the Manipulation of Money and Credit in 1978 
by Free Market Books. 

Translated from the original German by Bettina Bien Greaves and Percy L. 
Greaves, Jr. 

The Mises Institute would like to thank Bettina Bien Greaves for her sup- 
port and interest in this new edition. 

Foreword and new material copyright © 2006 by the Ludwig von Mises 

All rights reserved. No part of this book may be reproduced in any manner 
whatsoever without written permission except in the case of quotes in the 
context of reviews. For information write the Ludwig von Mises Institute, 
518 West Magnolia Avenue, Auburn, Alabama 36832; 

ISBN: 1-933550-03-1 
ISBN: 978-1-933550-03-9 


Foreword by Frank Shostak xi 

Introduction by Percy L. Greaves, Jr. xiii 

Chapter 1— Stabilization of the Monetary Unit 

—From the Viewpoint of Theory (1923) 1 

I. The Outcome of Inflation 2 

1. Monetary Depreciation 2 

2. Undesired Consequences 6 

3. Effect on Interest Rates 7 

4. The Run from Money 8 

5. Effect of Speculation 9 

6. Final Phases 10 

7. Greater Importance of Money to a Modern Economy ..12 

II. The Emancipation of Monetary Value 

From the Influence of Government 14 

1. Stop Presses and Credit Expansion 14 

2. Relationship of Monetary Unit to World Money 

-Gold 15 

3. Trend of Depreciation 16 

III. The Return to Gold 18 

1. Eminence of Gold 18 

2. Sufficiency of Available Gold 19 

IV. The Money Relation 21 

1. Victory and Inflation 21 

2. Establishing Gold “Ratio” 22 

V. Comments on the “Balance of Payments” Doctrine 25 

1. Refined Quantity Theory of Money 25 

vi — The Causes of the Economic Crisis 

2. Purchasing Power Parity 26 

3. Foreign Exchange Rates 27 

4. Foreign Exchange Regulations 29 

VI. The Inflationist Argument 31 

1. Substitute for Taxes 31 

2. Financing Unpopular Expenditures 32 

3. War Reparations 34 

4. The Alternatives 35 

5. The Government’s Dilemma 37 

VII. The New Monetary System 39 

1. First Steps 39 

2. Market Interest Rates 41 

VIII. The Ideological Meaning of Reform 43 

1. The Ideological Conflict 43 

Appendix: Balance of Payments and Foreign 

Exchange Rates 44 

Chapter 2— Monetary Stabilization and Cyclical 

Policy (1928) 53 

A. Stabilization of the Purchasing Power of 

the Monetary Unit 57 

I. The Problem 57 

1. “Stable Value” Money 57 

2. Recent Proposals 58 

II. The Gold Standard 60 

1. The Demand for Money 60 

2. Economizing on Money 62 

3. Interest on “Idle” Reserves 65 

4. Gold Still Money 67 

III. The “Manipulation of the Gold Standard” 68 

1. Monetary Policy and Purchasing Power of Gold 68 

2. Changes in Purchasing Power of Gold 71 

Contents — vii 

IV. “Measuring” Changes in the Purchasing 

Power of the Monetary Unit 73 

1. Imaginary Constructions 73 

2. Index Numbers 77 

V. Fisher’s Stabilization Plan 80 

1. Political Problem 80 

2. Multiple Commodity Standard 81 

3. Price Premium 82 

4. Changes in Wealth and Income 85 

5. Uncompensatable Changes 86 

VI. Goods-Induced and Cash-Induced Changes in the 

Purchasing Power of the Monetary Unit 88 

1. The Inherent Instability of Market Ratios 88 

2. The Misplaced Partiality to Debtors 91 

VII. The Goal of Monetary Policy 93 

1. Liberalism and the Gold Standard 93 

2. “Pure” Gold Standard Disregarded 94 

3. The Index Standard 96 

B. Cyclical Policy to Eliminate Economic Fluctuations 97 

I. Stabilization of the Purchasing Power 

of the Monetary Unit and Elimination 

of the Trade Cycle 97 

1. Currency School’s Contribution 97 

2. Early Trade Cycle Theories 99 

3. The Circulation Credit Theory 101 

II. Circulation Credit Theory 103 

1. The Banking School Fallacy 103 

2. Early Effects of Credit Expansion 

3. Inevitable Effects of Credit Expansion 

on Interest Rates 105 

4. The Price Premium 109 

5. Malinvestment of Available Capital 

Goods 109 

viii — The Causes of the Economic Crisis 

6. “Forced Savings” Ill 

7. A Habit- forming Policy 113 

8. The Inevitable Crisis and Cycle 113 

III. The Reappearance of Cycles 116 

1. Metallic Standard Fluctuations 116 

2. Infrequent Recurrences of Paper Money 

Inflations 117 

3. The Cyclical Process of Credit Expansions 119 

4. The Mania for Lower Interest Rates 121 

5. Free Banking 124 

6. Government Intervention in Banking 125 

7. Intervention No Remedy 127 

IV. The Crisis Policy of the Currency School 128 

1. The Inadequacy of the Currency School 128 

2. “Booms” Favored 130 

V. Modern Cyclical Policy 132 

1. Pre-World War I Policy 132 

2. Post- World War I Policies 133 

3. Empirical Studies 135 

4. Arbitrary Political Decisions 136 

5. Sound Theory Essential 138 

VI. Control of the Money Market 140 

1. International Competition or Cooperation 140 

2. “Boom” Promotion Problems 142 

3. Drive for Tighter Controls 144 

VII. Business Forecasting for Cyclical Policy and the 

Businessman 146 

1. Contributions of Business Cycle 

Research 146 

2. Difficulties of Precise Prediction 148 

VIII. The Aims and Method Cyclical Policy 149 

1. Revised Currency School Theory 149 

Contents — ix 

2. “Price Level” Stabilization 151 

3. International Complications 152 

4. The Future 153 

3— The Causes of the Economic Crisis (1931) 155 

I. The Nature and Role of the Market 155 

1. The Marxian “Anarchy of Production” Myth 155 

2. The Role and Rule of Consumers 156 

3. Production for Consumption 157 

4. The Perniciousness of a “Producers’ Policy” 159 

II. Cyclical Changes in Business Conditions 160 

1. Role of Interest Rates 160 

2. The Sequel of Credit Expansion 162 

III. The Present Crisis 163 

A. Unemployment 164 

1. The Market Wage Rate Process 164 

2. The Labor Union Wage Rate Concept 166 

3. The Cause of Unemployment 167 

4. The Remedy for Mass Unemployment 168 

5. The Effects of Government Intervention 169 

6. The Process of Progress 171 

B. Price Declines and Price Supports 172 

1. The Subsidization of Surpluses 172 

2. The Need for Readjustments 173 

C. Tax Policy 174 

1. The Anti-Capitalistic Mentality 174 

D. Gold Production 176 

1. The Decline in Prices 176 

2. Inflation as a “Remedy” 178 

IV. Is There a Way Out? 179 

1. The Cause of Our Difficulties 179 

2. The Unwanted Solution 180 

x — The Causes of the Economic Crisis 

4— The Current Status of Business Cycle Research 
and Its Prospects for the Immediate 

Future (1933) 183 

I. The Acceptance of the Circulation Credit Theory 

of Business Cycles 183 

II. The Popularity of Low Interest Rates 185 

III. The Popularity of Labor Union Policy 187 

IV. The Effect of Lower than Unhampered Market 

Interest Rates 188 

Y. The Questionable Fear of Declining Prices 188 

5— The Trade Cycle and Credit Expansion: The Economic 

Consequences of Cheap Money (1946) 191 

I. The Unpopularity of Interest 191 

II. The Two Classes of Credit 192 

III. The Function of Prices, Wage Rates, and Interest Rates ..195 

IV. The Effects of Politically Lowered Interest Rates 196 

V. The Inevitable Ending 201 

Index 203 


T his collection of articles on the business cycle, money, 
and exchange rates by Ludwig von Mises appeared 
between 1919 andl946. Here we have the evidence that 
the master economist foresaw and warned against the break- 
down of the German mark, as well as the market crash of 1929 
and the depression that followed. He presents his business cycle 
theory in its most elaborate form, applies it to the prevailing con- 
ditions, and discusses the policies that governments undertake 
that make recessions worse. He recommends a path for monetary 
reform that would eliminate business cycles as we have known 
them, and provide the basis for a sustainable prosperity. 

In foreseeing the interwar economic breakdown, Mises was 
nearly alone among his contemporaries — which is particularly 
interesting because Mises made no claim to possessing clairvoy- 
ant powers. To him, economics is a qualitative discipline. But 
among those who say that economics must be quantitative with 
the goal of accurate prediction, neither the pre-monetarists of the 
Fisher School nor the Keynesians foresaw the economic damage 
that would result from central bank policies that manipulate the 
supply of money and credit. Why is this? Most economists were 
looking at the price level and growth rates as indicators of eco- 
nomic health. Mises’s theoretical insights led him to look more 
deeply, and to elucidate the impact of credit expansion on the 
entire structure of the capitalistic production process. 

The essays were well known to contemporary German-speak- 
ing audiences. They had not come to the attention of English 
audiences until 1978, four years after F.A. Hayek had been 
awarded the Nobel Prize for, in particular, “his theory of business 


xii — The Causes of the Economic Crisis 

cycles and his conception of the effects of monetary and credit 
policies.” In tribute to Hayek’s excellent contributions, the 
Austrian theory of the business cycle has long been called a 
Hayekian theory. But it might be more justly called the Misesian 
theory, for it was Mises who first presented it in his 1912 book 
and elaborated it so fully in the essays presented herein. 

Although the articles address issues that were debated many 
years ago, the analysis presented by Mises are as relevant today as 
they were in his time. Mises reached his conclusions regarding 
events of the day by means of a coherent theory, as applied to 
current events, rather than attempting to derive a theory from 
data alone, as many of his contemporaries did. This is what gave 
his writings their predictive power then, and it is what makes his 
writings fresh and relevant today. A proper economic theory 
such as Mises presents here applies in all times and places. 

As in the past, most economists today believe that sophisti- 
cated mathematical and statistical methods can torture the data 
enough to reveal some causal link between events and yield a the- 
ory of inflation and the business cycle. But this is a senseless 
exercise. It is no more fruitful than a purely descriptive account 
and it has no more predictive value than a simple data extrapola- 

These essays have been buried in obscurity for far too long. 
Reading the writings of this great master economist might con- 
vince some economists and policy makers that there is no 
substitute for sound thinking. Economics is far too important a 
subject to be left in the hands of trend extrapolators, data tortur- 
ers, and monetary central planners who rely on them. 

Frank Shostak 
C hief Economist 
MAN Financial Australia 
March 2006 


Every boom must one day come to an end. 

— Ludwig von Mises (1928) 

The crisis from which we are now suffering is also the out- 
come of a credit expansion. 

— Ludwig von Mises (1931) 

I n the 1912 edition The Theory of Money and Credit, Ludwig 
von Mises foresaw the revival of inflation at a time when his 
contemporaries believed that no great nation would ever 
again resort to irredeemable paper money. This book also pre- 
sented his monetary theory of the trade cycle, a fundamental 
explanation of economic crises. Mises devoted a great part of his 
life to attempts to improve and elaborate on his presentation of 
what has since become known as the Austrian trade cycle theory. 
This volume includes several of those attempts which have not 
previously been available in English. 

The first, Stabilization of the Monetary Unit— From the 
Viewpoint of Theory, was sent to the printers in January 1923, more 
than eight months before the German mark crashed. In this contri- 
bution, Mises punctured the then popular fallacy that there is not 
enough gold available to serve as a sound medium of exchange. 

Adapted from the introduction to Ludwig von Mises, On the Manipulation 
of Money and Credit, edited by Percy L. Greaves, translated by Bettina Bien 
Greaves (Dobbs Ferry, N.Y.: Free Market Books, 1978). 

xiv — The Causes of the Economic Crisis 

The second contribution, Monetary Stabilization and Cyclical 
Policy, is probably Mises’s longest and most explicit piece on mis- 
guided attempts to stabilize the purchasing power of money and 
eliminate the undesired consequences of the “trade cycle.” He 
goes into more detail and explains more of the important points 
on which the monetary theory of the trade cycle is based than he 
does anywhere else. It appeared in 1928 and must have been 
completed early that year. Yet, with his usual exceptional fore- 
sight, he foresaw the futile policies that the Federal Reserve 
System was to follow from the 1928 fall election in the United 
States until the stock market crashed the following fall. 

Mises pointed out that if it ever became the task of govern- 
ments to influence the value of money by manipulating the 
quantity of its monetary units, the result would be a continual 
struggle of politically powerful groups for favors at the expense of 
others. Such struggles can only produce continual disturbances 
with results far less “stable” than the rules of the gold standard. 

In the first section of this essay, Mises demonstrates the 
inevitable failure of all attempts to attain a money with a “stable” 
purchasing power by manipulating the quantity. As he expresses 

There is no such thing as “stable” purchasing power, and 
never can be. The concept of “stable value” is vague and 
indistinct. Strictly speaking, only an economy in the 
final state of rest — where all prices remain unchanged — 
can have a money with fixed purchasing power. 

Mises shows conclusively that purchasing power cannot be 
measured. Consequently, there is no scientific basis for establish- 
ing a starting point for such an unattainable idea. The very 
concept of “stable value” denies flexibility to the myriads of mar- 
ket prices which actually reflect the ever-changing subjective 
values of all participants. 

No one knows the future, but so far as market participants can 
foresee the future, the anticipated future purchasing power of 
any monetary unit will be reflected in the “price premium” factor 

Introduction — xv 

in market interest rates. If prices are expected to rise continually, 
the longer the period of a loan, the higher the interest rate will be. 
Before the German mark crashed in 1923, interest rates of 90 
percent or more were considered low. 

Mises also points out that those who save and lend their sav- 
ings to productive efforts play a major role in raising production 
and living standards. It would seem that they are entitled to the 
free market fruits of their contributions. As just mentioned, 
unmanipulated interest rates would reflect market expectations 
of changes in the purchasing power of the monetary unit. 
However, if the principal of loans could be, and always were, 
repaid with sums representing the purchasing power originally 
borrowed, the lending savers would be prevented from sharing in 
the general progress and resulting lower prices their savings 
helped make possible. Then everybody but the lending saver 
would benefit from his savings. 

This would, of course, reduce the incentive for people to lend 
their savings to those who can make a more productive use of 
them. With less production, the living standards of all consumers 
would fall. So the “stable money” goal, even if it were achievable, 
would be a stumbling block to progress. All progress is the result 
of free-market incentives which lead enterprisers to attempt to 
improve on the “stable” patterns of the past. 

Mises also refers to the fact that deflation can never repair the 
damage of a priori inflation. In his seminar, he often likened such 
a process to an auto driver who had run over a person and then 
tried to remedy the situation by backing over the victim in 
reverse. Inflation so scrambles the changes in wealth and income 
that it becomes impossible to undo the effects. Then too, defla- 
tionary manipulations of the quantity of money are just as 
destructive of market processes, guided by unhampered market 
prices, wage rates and interest rates, as are such inflationary 
manipulations of the quantity of money. 

The second part of the 1928 piece is a masterpiece in which 
Mises shows how the artificial lowering of interest rates intensi- 
fies the demand for credit that can only be met by a credit 

xvi — The Causes of the Economic Crisis 

expansion. This addition to the quantity of money that can be 
spent in the market place must lead to a step-by-step redirection 
of the economy by raising certain prices and wage rates before 
others are affected, as the recipients of this newly created credit 
bid for available supplies of what they want but could not buy 
without having obtained the newly created credit. 

Mises was then writing at a time when such credit expansion 
was primarily in the form of discounting short term (not longer 
than 90 days) bills of exchange. Consequently, such loans were 
always business loans. The first consequence was always a bid- 
ding up of the prices of certain raw materials, capital goods, and 
wage rates, for which the borrowers spent their newly acquired 
credit. This has led some writers on the subject to believe that all 
such loans went into the lengthening of the production period. 
Some did, of course, but Mises recognized that the lower interest 
rates attracted all producers who could use borrowed funds. 
Consequently all the resulting malinvestment does not result in 
longer processes. The effects depend on just who the borrowers 
are and how they spend their new credit in the market. 

Since 1928, banks have extended credit expansion not only to 
business but also to consumers, and not only for short term loans 
but also for long term loans, so that the specific effects of credit 
expansion today are somewhat different than they were in the 
1920’s. However, the results are still, as Mises pointed out, a step- 
by-step misdirection in the use and production of available goods 
and services. As Mises wrote in 1928, as well as in Human Action, 
the result is not overinvestment, as some have thought, but malin- 
vestment. Investment is always limited by what is available. 

Although later and better statistics are now available and the 
Harvard “barometers” have been superseded by computer mod- 
els, what Mises said then about the Harvard “barometers” also 
applies to the statistics gathered and rearranged by the more 
sophisticated computer techniques of today. Such research mate- 
rials may support Mises’s theory, but they provide little help in 
furnishing an answer to the problem of finding the cause of 
recessions and depressions so that the cause may be eliminated. 

Introduction — xvii 

The answer, as Mises attests, is a return to free market interest 
rates which restrain loans to available savings, i.e., the elimination 
of credit expansion, a system whereby banks lend more funds than 
they have available for lending by the artificial creation of mone- 
tary units in the form of bank accounts subject to withdrawal by 
checks. Mises saw the answer in free banking, with banks subject 
only to the commercial and bankruptcy laws that apply to all other 
forms of business. 

In 1928, Mises also foresaw the attempts now being made to 
remove the brakes on credit expansion by international agree- 
ments. He recognized that if all major governments could ever be 
persuaded to expand credit at the same rate, it might then 
become more difficult for the residents of individual countries to 
detect the expansion or to check the expansion by sending their 
funds to countries where there was less credit expansion. 

While Mises refined his presentation, particularly his scien- 
tific terminology, by the time he wrote Human Action, this 1928 
contribution establishes him as the unquestioned originator of 
the monetary “Austrian” theory of the trade cycle. Others have 
since written on the subject. None has substantially added to, or 
subtracted from, his presentation. 

This basic explanation is very late in appearing in English. It is 
to be hoped that it will correct some of the misunderstandings 
resulting from the writings of others that have preceded its 
English appearance. This great contribution to human knowl- 
edge should be read by all those interested in saving our 
capitalistic civilization and capable of spreading a better under- 
standing of the inherent dangers to our society in the political 
manipulation of money and credit. 

The third contribution, The Causes of the Economic Crisis, is a 
translation of a speech he gave at the depth of the Great 
Depression on February 28, 1931, before a group of German indus- 
trialists. After a clear but simple presentation of consumer 
sovereignty in an unhampered market society, Mises described 
how the lowered interest rates produced the then current crisis. He 
goes on to explain the duration of the crisis as the result of other 
interventionist hamperings of market processes. He shows that 

xviii — The Causes of the Economic Crisis 

continued mass unemployment is due to interference with free 
market wage rates. He also shows how political interventions 
affecting prices, as well as heavy taxes on capital and its yield, had 
hindered recovery. 

In this speech, five years before the appearance in 1936 of 
Keynes’s The General Theory of Employment, Interest and Money, 
Mises made a devastating criticism of the basic Keynesian tenet 
that has since become so popular. It is the idea that inflation can 
bring the higher than free market wage rates extorted by labor 
unions into a viable relationship with other costs. Accepting the 
idea that it was politically impossible to reduce the higher than 
free market union wage rates that had produced mass unemploy- 
ment, Keynes proposed to lower the real wages of all workers by 
lowering the value of the monetary unit, i.e., inflation. 
Unfortunately, England’s inflation only lowered the real wages of 
the privileged union members temporarily, while disorganizing 
the nation’s whole market economy. This, in turn, created a 
clamor for more political interventions that sponsors hoped 
would correct the undesired results of the inflation. 

Mises correctly foresaw that the politically feared labor unions 
would, sooner or later, insist on higher money wages. The even- 
tual solution, as Mises has maintained, must be a return to free 
market wage rates. He was certainly many years a head of his 
time. There is still a popular feeling that inflation is a means of 
offsetting unemployment, with little recognition that such infla- 
tions must inevitably lead to the undesired recessionary 
consequences that every responsible person wants to prevent. 

The fourth piece is a translation of a 1933 contribution he 
made to Arthur Spiethoff’s Festschrift devoted to the status and 
prospects of business cycle research. Mises used to say that all a 
good economist needed was some sound ideas, writing materials, 
an armchair, and a waste basket. He, of course, recommended 
wide reading but he insisted that it was the ideas that were 
important and that without ideas all statistics were meaningless. 

In this piece Mises comments on the clamor for cheap credit. 
Throughout history there have been governments that have 
sponsored high prices and governments that have sponsored low 

Introduction — xix 

prices, but all governments have been advocates of low interest 
rates. Politicians never seem to learn that the best way to attain 
low interest rates is to stop inflating the quantity of money and 
remove all obstacles to the greater accumulation of capital. Mises 
also explodes the naive inflationist theory that prosperity 
requires ever-rising prices. 

The final piece is not a translation. It was prepared in early 
1946 for an American business association for which Mises served 
as a consultant. He discusses his cycle theory in the American 
milieu and points out that low interest rates actually hurt the 
American masses who, as savings bank depositors, life insurance 
policy holders and beneficiaries of pension funds, are the credi- 
tors of large corporations and governmental bodies which are 
today the major borrowers of savings. He also gives a clear expla- 
nation of the important difference between “commodity credit” 
and “circulation credit.” It is the latter which is so disastrous in dis- 
organizing free market guidelines. Our real problem is not a 
shortage of money, but a shortage of the factors of production 
needed to produce more of the things that consumers want. 

While Mises’s most valuable contributions were not always 
easy reading, he did not lapse into abstruse or convoluted esoter- 
ics. He wrote what he had to say simply and directly, perhaps on 
some occasions too simply and too concisely for many readers to 
grasp the full implications which he did not always spell out. He 
had a dislike for translations. He maintained that each language 
group had some ideas, customs, and traditions which were 
impossible to translate accurately into the languages of another 
language group with different ideas, customs, and traditions. He 
would ask, how could such thoroughly American traditions as 
college fraternities and football extravaganzas be translated into 
the German language, which had no precise terms for expressing 
such alien ideas. 

My wife, Bettina Bien Greaves, started these translations a few 
years after she became a student of Mises. In the years that have 
intervened, she has become one of his most careful students. She 
prepared a bibliography of his works, catalogued his library, 
attended his seminar for eighteen years, and assisted him in 

xx — The Causes of the Economic Crisis 

many ways. In 1971, Mises approved the publication of these 
translations when he was assured that they would be edited by 
the undersigned, also a long-time and serious student of Mises’s 

The completion of this project has taken longer than expected. 
However, no effort has been spared in the attempt to present 
Mises’s ideas in a form we hope he would have approved. We trust 
this volume will lead to a better understanding of Mises’s contribu- 
tions to man’s knowledge of money, credit, and the trade cycle. 

Percy L. Greaves, Jr., Editor 
July 4, 1977 


Stabilization of the Monetary Unit — 
From the Viewpoint of Theory (1923) 

A ttempts to stabilize the value of the monetary unit 
strongly influence the monetary policy of almost every 
nation today. They must not be confused with earlier 
endeavors to create a monetary unit whose exchange value would 
not be affected by changes from the money side . 1 In those olden, 
and happier times, the concern was with how to bring the quan- 
tity of money into balance with the demand, without changing 
the purchasing power of the monetary unit. Thus, attempts were 
made to develop a monetary system under which no changes 
would emerge from the side of money to alter the ratios between 
the generally used medium of exchange (money) and other eco- 
nomic goods. The economic consequences of the widely 
deplored changes in the value of money were to be completely 

Die geldtheoretische Seite des Stabilisierungsproblems (Schriften des Vereins 
fur Sozialpolitik 164, part 2 [Munich and Leipzig: Duncker and Humblot, 
1923]). The original manuscript for this essay was completed and submit- 
ted by the author to the printer in January 1923, more than eight months 
before the final breakdown of the German mark. 

1 [Following the terminology of Carl Menger, Mises wrote here of changes 
in the “internal objective exchange value” of the monetary unit. However, 
in this translation, the more familiar English term, later adopted by Mises, 
will be used — i.e, changes in the value of the monetary unit arising on the 
money side or, simply, “cash-induced changes.” Menger’s term for changes 
in the monetary unit’s “external exchange value” will be rendered as 
“changes from the goods side” or “goods-induced changes.” See below p. 76, 
note 17. Also Mises’s Human Action (1949; 1963 [Chicago: Contemporary 
Books, 1966], p. 419; Scholar’s Edition [Auburn, Ala.: Ludwig von Mises 
Institute, 1998], p. 416).— Ed.] 


2 — The Causes of the Economic Crisis 

There is no point nowadays in discussing why this goal could 
not then, and in fact cannot, be attained. Today we are motivated 
by other concerns. We should be happy just to return again to the 
monetary situation we once enjoyed. If only we had the gold stan- 
dard back again, its shortcomings would no longer disturb us; we 
would just have to make the best of the fact that even the value of 
gold undergoes certain fluctuations. 

Today’s monetary problem is a very different one. During and 
after the war [World War I, 1914-1918], many countries put into 
circulation vast quantities of credit money, which were endowed 
with legal tender quality. In the course of events described by 
Gresham’s Law, gold disappeared from monetary circulation in 
these countries. These countries now have paper money, the pur- 
chasing power of which is subject to sudden changes. The 
monetary economy is so highly developed today that the disadvan- 
tages of such a monetary system, with sudden changes brought 
about by the creation of vast quantities of credit money, cannot be 
tolerated for long. Thus the clamor to eliminate the deficiencies in 
the field of money has become universal. People have become con- 
vinced that the restoration of domestic peace within nations and 
the revival of international economic relations are impossible with- 
out a sound monetary system. 


The Outcome of Inflation 2 

1. Monetary Depreciation 

If the practice persists of covering government deficits with 
the issue of notes, then the day will come without fail, sooner or 
later, when the monetary systems of those nations pursuing this 
course will break down completely. The purchasing power of the 

2 [Mises uses the term “inflation” in its historical and scientific sense as an 
increase in the quantity of money.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 3 

monetary unit will decline more and more, until finally it disap- 
pears completely. To be sure, one could conceive of the possibility 
that the process of monetary depreciation could go on forever. 
The purchasing power of the monetary unit could become 
increasingly smaller without ever disappearing entirely. Prices 
would then rise more and more. It would still continue to be pos- 
sible to exchange notes for commodities. Finally, the situation 
would reach such a state that people would be operating with bil- 
lions and trillions and then even higher sums for small 
transactions. The monetary system would still continue to func- 
tion. However, this prospect scarcely resembles reality. 

In the long run, trade is not helped by a monetary unit which 
continually deteriorates in value. Such a monetary unit cannot be 
used as a “standard of deferred payments .” 3 Another intermediary 
must be found for all transactions in which money and goods or 
services are not exchanged simultaneously. Nor is a monetary unit 
which continually depreciates in value serviceable for cash transac- 
tions either. Everyone becomes anxious to keep his cash holding, on 
which he continually suffers losses, as low as possible. All incoming 
money will be quickly spent. When purchases are made merely to 
get rid of money, which is shrinking in value, by exchanging it for 
goods of more enduring worth, higher prices will be paid than are 
otherwise indicated by other current market relationships. 

In recent months, the German Reich has provided a rough 
picture of what must happen, once the people come to believe 
that the course of monetary depreciation is not going to be 
halted. If people are buying unnecessary commodities, or at least 
commodities not needed at the moment, because they do not 
want to hold on to their paper notes, then the process which 
forces the notes out of use as a generally acceptable medium of 
exchange has already begun. This is the beginning of the “demon- 
etization” of the notes. The panicky quality inherent in the 
operation must speed up the process. It may be possible to calm 

3 [Here in the German text Mises used, without special comment, the 
English term “standard of deferred payments.” For his reasons, see below, p. 
58, note 3.— Ed.] 

4 — The Causes of the Economic Crisis 

the excited masses once, twice, perhaps even three or four times. 
However, matters must finally come to an end. Then there is no 
going back. Once the depreciation makes such rapid strides that 
sellers are fearful of suffering heavy losses, even if they buy again 
with the greatest possible speed, there is no longer any chance of 
rescuing the currency. 

In every country in which inflation has proceeded at a rapid 
pace, it has been discovered that the depreciation of the money 
has eventually proceeded faster than the increase in its quantity. 
If “m” represents the actual number of monetary units on hand 
before the inflation began in a country, “P” represents the value 
then of the monetary unit in gold, “M” the actual number of 
monetary units which existed at a particular point in time during 
the inflation, and “p” the gold value of the monetary unit at that 
particular moment, then (as has been borne out many times by 
simple statistical studies): 

mP > Mp. 

On the basis of this formula, some have tried to conclude that 
the devaluation had proceeded too rapidly and that the actual 
rate of exchange was not justified. From this, others have con- 
cluded that the monetary depreciation is not caused by the 
increase in the quantity of money, and that obviously the 
Quantity Theory could not be correct. Still others, accepting the 
primitive version of the Quantity Theory, have argued that a fur- 
ther increase in the quantity of money was permissible, even 
necessary. The increase in the quantity of money should con- 
tinue, they maintain, until the total gold value of the quantity of 
money in the country was once more raised to the height at 
which it was before the inflation began. Thus: 

Mp = mP. 

The error in all this is not difficult to recognize. For the 
moment, let us disregard the fact — which will be analyzed more 
fully below — that at the start of the inflation the rate of exchange 
on the Bourse , 4 as well as the agio [premium] against metals, 

4 Bourse (French). A continental European stock exchange, on which 
trades are also made in commodities and foreign exchange. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 5 

races ahead of the purchasing power of the monetary unit 
expressed in commodity prices. Thus, it is not the gold value of 
the monetary units, but their temporarily higher purchasing 
power vis-a-vis commodities which should be considered. Such a 
calculation, with “P” and “p” referring to the monetary unit’s pur- 
chasing power in commodities rather than to its value in gold, 
would also lead, as a rule, to this result: 

mP > Mp. 

However, as the monetary depreciation progresses, it is evident 
that the demand for money, that is for the monetary units already 
in existence, begins to decline. If the loss a person suffers becomes 
greater the longer he holds on to money, he will try to keep his 
cash holding as low as possible. The desire of every individual for 
cash no longer remains as strong as it was before the start of the 
inflation, even if his situation may not have otherwise changed. As 
a result, the demand for money throughout the entire economy, 
which can be nothing more than the sum of the demands for 
money on the part of all individuals in the economy, goes down. 

To the extent to which trade gradually shifts to using foreign 
money and actual gold instead of domestic notes, individuals no 
longer invest in domestic notes but begin to put a part of their 
reserves in foreign money and gold. In examining the situation in 
Germany, it is of particular interest to note that the area in which 
Reichsmarks circulate is smaller today than in 1914, 5 and that now, 
because they have become poorer, the Germans have substantially 
less use for money. These circumstances, which reduce the demand 
for money, would exert much more influence if they were not coun- 
teracted by two factors which increase the demand for money: 

(1) The demand from abroad for paper marks, which contin- 
ues to some extent today, among speculators in foreign 
exchange (Valuta); and 

5 The Treaty of Versailles at the end of World War I (1914-1918) reduced 
German controlled territory considerably, restored Alsace-Lorraine to 
France, ceded large parts of West Prussia and Posen to Poland, ceded small 
areas to Belgium and stripped Germany of her former colonies in Africa 
and Asia. 

6 — The Causes of the Economic Crisis 

(2) The fact that the impairment of [credit] techniques for 
making payments, due to the general economic deteriora- 
tion, may have increased the demand for money [cash 
holdings] above what it would have otherwise been. 

2. Undesired Consequences 

If the future prospects for a money are considered poor, its 
value in speculations, which anticipate its future purchasing 
power, will be lower than the actual demand and supply situation 
at the moment would indicate. Prices will be asked and paid 
which more nearly correspond to anticipated future conditions 
than to the present demand for, and quantity of, money in circu- 

The frenzied purchases of customers who push and shove in the 
shops to get something, anything, race on ahead of this develop- 
ment; and so does the course of the panic on the Bourse where 
stock prices, which do not represent claims in fixed sums of 
money, and foreign exchange quotations are forced fitfully upward. 
The monetary units available at the moment are not sufficient to 
pay the prices which correspond to the anticipated future demand 
for, and quantity of, monetary units. So trade suffers from a short- 
age of notes. There are not enough monetary units [or notes] on 
hand to complete the business transactions agreed upon. The 
processes of the market, which bring total demand and supply into 
balance by shifting exchange ratios [prices], no longer function so 
as to bring about the exchange ratios which actually exist at the 
time between the available monetary units and other economic 
goods. This phenomenon could be clearly seen in Austria in the 
late fall of 1921. 6 The settling of business transactions suffered seri- 
ously from the shortage of notes. 

6 [The post World War I inflation in Austria is not as well known as the 
German inflation of 1923. The Austrian crown depreciated disastrously at 
that time, although not to the same extent as the German mark. The leader 
of the Christian-Social Party and Chancellor of Austria (1922-1924 and 
1926-1929), Dr. Ignaz Seipel (1876-1932), acting on the advice of 
Professor Mises and some of his associates, succeeded in stopping the 
Austrian inflation in 1922. — Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 7 

Once conditions reach this stage, there is no possible way to 
avoid the undesired consequences. If the issue of notes is further 
increased, as many recommend, then things would only be made 
still worse. Since the panic would keep on developing, the dispro- 
portionality between the depreciation of the monetary unit and 
the quantity in circulation would become still more exaggerated. 
The shortage of notes for the completion of transactions is a phe- 
nomenon of advanced inflation. It is the other side of the frenzied 
purchases and prices; it is the other side of the “crack-up boom.” 

3. Effect on Interest Rates 

Obviously, this shortage of monetary units should not be con- 
fused with what the businessman usually understands by a 
scarcity of money, accompanied by an increase in the interest 
rate for short term investments. An inflation, whose end is not in 
sight, brings that about also. The old fallacy — long since refuted 
by David Hume and Adam Smith — to the effect that a scarcity of 
money, as defined in the businessman’s terminology, may be alle- 
viated by increasing the quantity of money in circulation, is still 
shared by many people. Thus, one continues to hear astonish- 
ment expressed at the fact that a scarcity of money prevails in 
spite of the uninterrupted increase in the number of notes in cir- 
culation. However, the interest rate is then rising, not in spite of, 
but precisely on account of, the inflation. 

If a halt to the inflation is not anticipated, the money lender 
must take into consideration the fact that, when the borrower 
ultimately repays the sum of money borrowed, it will then repre- 
sent less purchasing power than originally lent out. If the money 
lender had not granted credit but instead had used his money 
himself to buy commodities, stocks, or foreign exchange, he 
would have fared better. In that case, he would have either 
avoided loss altogether or suffered a lower loss. If he lends his 
money, it is the borrower who comes out well. If the borrower 
buys commodities with the borrowed money and sells them later, 
he has a surplus after repaying the borrowed sum. The credit 
transaction yields him a profit, a real profit, not an illusory, infla- 
tionary profit. Thus, it is easy to understand that, as long as the 

8 — The Causes of the Economic Crisis 

continuation of monetary depreciation is expected, the money 
lender demands, and the borrower is ready to pay, higher interest 
rates. Where trade or legal practices are antagonistic to an 
increase in the interest rate, the making of credit transactions is 
severely hampered. This explains the decline in savings among 
those groups of people for whom capital accumulation is possible 
only in the form of money deposits at banking institutions or 
through the purchase of securities at fixed interest rates. 

4. The Run from Money 

The divorce of a money, which is proving increasingly useless, 
from trade begins when it starts coming out of hoarding. If peo- 
ple want marketable goods available to meet unanticipated future 
needs, they start to accumulate other moneys — for instance, 
metallic (gold and silver) moneys, foreign notes, and occasionally 
also domestic notes which are valued more highly because their 
quantity cannot be increased by the government, such as the 
Romanov ruble of Russia or the “blue” money of Communist 
Hungary. 7 Then too, for the same purpose, people begin to 
acquire metal bars, precious stones and pearls, even pictures, 
other art objects and postage stamps. An additional step in dis- 
placing a no-longer-useful money is the shift to making credit 
transactions in foreign currencies or metallic commodity money 
which, for all practical purposes, means only gold. Finally, if the 
use of domestic money comes to a halt even in commodity trans- 
actions, wages too must be paid in some other way than with 
pieces of paper with which transactions are no longer being made. 

Only the hopelessly confirmed statist can cherish the hope 
that a money, continually declining in value, may be maintained 
in use as money over the long run. That the German mark is still 
used as money today [January 1923] is due simply to the fact that 
the belief generally prevails that its progressive depreciation will 

7 Moneys issued by no longer existing governments. The Romanovs were 
thrown out of power in Russia by the Communist Revolution in 1917; 
Hungary’s post World War I Communist government lasted only from 
March 21, to August 1, 1919. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 9 

soon stop, or perhaps even that its value per unit will once more 
improve. The moment that this opinion is recognized as unten- 
able, the process of ousting paper notes from their position as 
money will begin. If the process can still be delayed somewhat, it 
can only denote another sudden shift of opinion as to the state of 
the mark’s future value. The phenomena described as frenzied 
purchases have given us some advance warning as to how the 
process will begin. It may be that we shall see it run its full course. 

Obviously the notes cannot be forced out of their position as 
the legal media of exchange, except by an act of law. Even if they 
become completely worthless, even if nothing at all could be pur- 
chased for a billion marks, obligations payable in marks could 
still be legally satisfied by the delivery of mark notes. This means 
simply that creditors, to whom marks are owed, are precisely 
those who will be hurt most by the collapse of the paper standard. 
As a result, it will become impossible to save the purchasing 
power of the mark from destruction. 

5. Effect of Speculation 

Speculators actually provide the strongest support for the 
position of the notes as money. Yet, the current statist explana- 
tion maintains exactly the opposite. According to this doctrine, 
the unfavorable configuration of the quotation for German 
money since 1914 is attributed primarily, or at least in large part, 
to the destructive effect of speculation in anticipation of its 
decline in value. In fact, conditions were such that during the war, 
and later, considerable quantities of marks were absorbed abroad 
precisely because a future rally of the mark’s exchange rate was 
expected. If these sums had not been attracted abroad, they 
would necessarily have led to an even steeper rise in prices on the 
domestic market. It is apparent everywhere, or at least it was 
until recently, that even residents within the country anticipated 
a further reduction of prices. One hears again and again, or used 
to hear, that everything is so expensive now that all purchases, 
except those which cannot possibly be postponed, should be put 
off until later. Then again, on the other hand, it is said that the 
state of prices at the moment is especially favorable for selling. 

10 — The Causes of the Economic Crisis 

However, it cannot be disputed that this point of view is already 
on the verge of undergoing an abrupt change. 

Placing obstacles in the way of foreign exchange speculation, 
and making transactions in foreign exchange futures especially 
difficult, was detrimental to the formation of the exchange rate for 
notes. Still, not even speculative activity can help at the time when 
the opinion becomes general that no hope remains for stopping 
the progressive depreciation of the money. Then, even the opti- 
mists will retreat from German marks and Austrian crowns, part 
company with those who anticipate a rise and join with those who 
expect a decline. Once only one view prevails on the market, there 
can be no more exchanges based on differences of opinion. 

6. Final Phases 

The process of driving notes out of service as money can take 
place either relatively slowly or abruptly in a panic, perhaps in 
days or even hours. If the change takes place slowly that means 
trade is shifting, step-by-step, to the general use of another 
medium of exchange in place of the notes. This practice of mak- 
ing and settling domestic transactions in foreign money or in gold, 
which has already reached substantial proportions in many 
branches of business, is being increasingly adopted. As a result, to 
the extent that individuals shift more and more of their cash hold- 
ings from German marks to foreign money, still more foreign 
exchange enters the country. As a result of the growing demand 
for foreign money, various kinds of foreign exchange, equivalent 
to a part of the value of the goods shipped abroad, are imported 
instead of commodities. Gradually, there is accumulated within 
the country a supply of foreign moneys. This substantially softens 
the effects of the final breakdown of the domestic paper standard. 
Then, if foreign exchange is demanded even in small transactions, 
if, as a result, even wages must be paid in foreign exchange, at first 
in part and then in full, if finally even the government recognizes 
that it must do the same when levying taxes and paying its offi- 
cials, then the sums of foreign money needed for these purposes 
are, for the most part, already available within the country. The 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 11 

situation, which emerges then from the collapse of the govern- 
ment’s currency, does not necessitate barter, the cumbersome 
direct exchange of commodities against commodities. Foreign 
money from various sources then performs the service of money, 
even if somewhat unsatisfactorily. 

Not only do incontrovertible theoretical considerations lead 
to this hypothesis. So does the experience of history with cur- 
rency breakdowns. With reference to the collapse of the 
“Continental Currency” in the rebellious American colonies 
(1781), Horace White says: “As soon as paper was dead, hard 
money sprang to life, and was abundant for all purposes. Much 
had been hoarded and much more had been brought in by the 
French and English armies and navies. It was so plentiful that for- 
eign exchange fell to a discount.” 8 

In 1796, the value of French territorial mandats fell to zero. 
Louis Adolphe Thiers commented on the situation as follows: 

Nobody traded except for metallic money. The specie, which 
people had believed hoarded or exported abroad, found its 
way back into circulation. That which had been hidden 
appeared. That which had left France returned. The southern 
provinces were full of piasters, which came from Spain, drawn 
across the border by the need for them. Gold and silver, like 
all commodities, go wherever demand calls them. An 
increased demand raises what is offered for them to the point 
that attracts a sufficient quantity to satisfy the need. People 
were still being swindled by being paid in mandats, because 
the laws, giving legal tender value to paper money, permitted 
people to use it for the satisfaction of written obligations. But 
few dared to do this and all new agreements were made in 
metallic money. In all markets, one saw only gold or silver. 

The workers were also paid in this manner. One would have 
said there was no longer any paper in France. The mandats 
were then found only in the hands of speculators, who 

8 Horace White, Money and Banking: Illustrated by American History 
(Boston, 1895), p. 142. [NOTE: We could not locate a copy of the 1895 edi- 
tion to verify this quotation. However, it appears, without the last sentence, 
in the 5th (1911) edition, p. 99.— Ed.] 

12 — The Causes of the Economic Crisis 

received them from the government and resold them to the 
buyers of national lands. In this way, the financial crisis, 
although still existing for the state, had almost ended for pri- 
vate persons. 9 

7. Greater Importance of Money 
to a Modern Economy 

Of course, one must be careful not to draw a parallel between 
the effects of the catastrophe, toward which our money is racing 
headlong on a collision course, with the consequences of the two 
events described above. In 1781, the United States was a predom- 
inantly agricultural country. In 1796, France was also at a much 
lower stage in the economic development of the division of labor 
and use of money and, thus, in cash and credit transactions. In an 
industrial country, such as Germany, the consequences of a mon- 
etary collapse must be entirely different from those in lands 
where a large part of the population remains submerged in prim- 
itive economic conditions. 

9 Louis Adolphe Thiers, Histoire de la Revolution f'rancaise, 7th ed., vol. 
V (Brussels, 1838), p. 171. The interpretation placed on these events by the 
“School” of G.F. Knapp is especially fantastic. See H. Illig’s Das Geldwesen 
Frankreichs zur Zeit der ersten Revolution bis zum Ende der 
Papiergeldwdhrung [The French monetary system at the time of the first 
revolution to the end of the paper currency] (Strassburg, 1914), p. 56. After 
mentioning attempts by the state to “manipulate the exchange rate of sil- 
ver,” he points out: “Attempts to reintroduce the desired cash situation 
began to succeed in 1796.” Thus, even the collapse of the paper money 
standard was a “success” for the State Theory of Money. [NOTE: The “State 
Theory of Money” has been the basis of the monetary policies of most gov- 
ernments in this century. Mises frequently credited the book of Georg 
Friedrich Knapp (3rd German edition, 1921; English translation by H.M. 
Lucas and J. Bonar, State Theory of Money, London, 1924) for having pop- 
ularized it among German- speaking peoples. Knapp held that money was 
whatever the government decreed to be money— individuals acting and 
trading on the market had nothing to do with it. See Mises’s The Theory of 
Money and Credit (New Haven, Conn.: Yale University Press, 1953), pp. 
463-69; and (Indianapolis, Ind.: LibertyC/asszcs, 1980), pp. 506-12.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 13 

Things will necessarily be much worse if the breakdown of the 
paper money does not take place step-by-step, but comes, as now 
seems likely, all of a sudden in panic. The supplies within the 
country of gold and silver money and of foreign notes are 
insignificant. The practice, pursued so eagerly during the war, of 
concentrating domestic stocks of gold in the central banks and 
the restrictions, for many years placed on trade in foreign mon- 
eys, have operated so that the total supplies of hoarded good 
money have long been insufficient to permit a smooth develop- 
ment of monetary circulation during the early days and weeks 
after the collapse of the paper note standard. Some time must 
elapse before the amount of foreign money needed in domestic 
trade is obtained by the sale of stocks and commodities, by rais- 
ing credit, and by withdrawing balances from abroad. In the 
meantime, people will have to make out with various kinds of 
emergency money tokens. 

Precisely at the moment when all savers and pensioners are 
most severely affected by the complete depreciation of the notes, 
and when the government’s entire financial and economic policy 
must undergo a radical transformation, as a result of being denied 
access to the printing press, technical difficulties will emerge in 
conducting trade and making payments. It will become immedi- 
ately obvious that these difficulties must seriously aggravate the 
unrest of the people. Still, there is no point in describing the spe- 
cific details of such a catastrophe. They should only be referred to 
in order to show that inflation is not a policy that can be carried on 
forever. The printing presses must be shut down in time, because 
a dreadful catastrophe awaits if their operations go on to the end. 
No one can say how far we still are from such a finish. 

It is immaterial whether the continuation of inflation is con- 
sidered desirable or merely not harmful. It is immaterial whether 
inflation is looked on as an evil, although perhaps a lesser evil in 
view of other possibilities. Inflation can be pursued only so long 
as the public still does not believe it will continue. Once the peo- 
ple generally realize that the inflation will be continued on and on 
and that the value of the monetary unit will decline more and 

14 — The Causes of the Economic Crisis 

more, then the fate of the money is sealed. Only the belief, that 
the inflation will come to a stop, maintains the value of the notes. 


The Emancipation of 
Monetary Value From the 
Influence of Government 

1. Stop Presses and Credit Expansion 

The first condition of any monetary reform is to halt the print- 
ing presses. Germany must refrain from financing government 
deficits by issuing notes, directly or indirectly. The Reichsbank 
[Germany’s central bank from 1875 until shortly after World War 
II] must not further expand its notes in circulation. Reichsbank 
deposits should be opened and increased, only upon the transfer 
of already existing Reichsbank accounts, or in exchange for pay- 
ment in notes, or other domestic or foreign money. The 
Reichsbank should grant credits only to the extent that funds are 
available — from its own reserves and from other resources put at 
its disposal by creditors. It should not create credit to increase 
the amount of its notes, not covered by gold or foreign money, or 
to raise the sum of its outstanding liabilities. Should it release any 
gold or foreign money from its reserves, then it must reduce to 
that same extent the circulation of its notes or the use of its obli- 
gations in transfers. 10 

Absolutely no evasions of these conditions should be 
tolerated. However, it might be possible to permit a limited increase 
— for two or three weeks at a time — only to facilitate clearings at the 

10 Foreign currencies and similar legal claims could possibly be classed as 
foreign money. However, foreign money here obviously means only the 
money of countries with at least fairly sound monetary conditions. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 15 

end of quarters, especially at the close of September and December. 
This additional circulation credit introduced into the economy, 
above the otherwise strictly-adhered to limits, should be statisti- 
cally moderate and generally precisely prescribed by law . 11 

There can be no doubt but what this would bring the contin- 
uing depreciation of the monetary unit to an immediate and 
effective halt. An increase in the purchasing power of the 
German monetary unit would even appear then — to the extent 
that the previous purchasing power of the German monetary 
unit, relative to that of commodities and foreign exchange, 
already reflected the view that the inflation would continue. This 
increase in purchasing power would rise to the point which cor- 
responded to the actual situation. 

2. Relationship of Monetary Unit to 
World Money— Gold 

However, stopping the inflation by no means signifies stabi- 
lization of the value of the German monetary unit in terms of 
foreign money. Once strict limits are placed on any further infla- 
tion, the quantity of German money will no longer be changing. 
Still, with changes in the demand for money, changes will also be 
taking place in the exchange ratios between German and foreign 
moneys. The German economy will no longer have to endure the 
disadvantages that come from inflation and continual monetary 
depreciation; but it will still have to face the consequences of the 
fact that foreign exchange rates remain subject to continual, even 
if not severe, fluctuations. 

11 [Mises later developed his position on these matters more fully. He 
withdrew his endorsement of even such a carefully prescribed legal exemp- 
tion as this to his general thesis that money and banking should be free of 
legislative interference. Even clearing arrangements among the banks 
should be left to the vicissitudes of the market. See his plea for free bank- 
ing in Monetary Stabilization and Cyclical Policy (1928) in this volume 
especially pp. 124-25 below. Also in Human Action, chapter XVII, section 
12 on “Indirect Exchange” and the essay on “Monetary Reconstruction” 
written for publication as the Epilogue to the 1953 (and later) editions of 
The Theory of Money and Credit.— Ed.] 

16 — The Causes of the Economic Crisis 

If, with the suspension of printing press operations, the mone- 
tary policy reforms are declared at an end, then obviously the 
value of the German monetary unit in relation to the world 
money, gold, would rise, slowly but steadily. For the supply of gold, 
used as money, grows steadily due to the output of mines while 
the quantity of the German money [not backed by gold or foreign 
money] would be limited once and for all. Thus, it should be con- 
sidered quite likely that the repercussions of changes in the 
relationship between the quantity of, and demand for, money in 
Germany and in gold standard countries would cause the German 
monetary unit to rise on the foreign exchange market. An illustra- 
tion of this is furnished by the developments of the Austrian 
money on the foreign exchange market in the years 1888-1891. 

To stabilize the relative value of the monetary unit beyond a 
nation’s borders, it is not enough simply to free the formation of 
monetary value from the influence of government. An effort 
should also be made to establish a connection between the world 
money and the German monetary unit, firmly binding the value 
of the Reichsmark to the value of gold. 

It should be emphasized again and again that stabilization of 
the gold value of a monetary unit can only be attained if the print- 
ing presses are silenced. Every attempt to accomplish this by other 
means is futile. It is useless to interfere on the foreign exchange 
market. If the German government acquires dollars, perhaps 
through a loan, and sells the loan for paper marks, it is exerting 
pressure, in the process, on the dollar exchange rate. However, if 
the printing presses continue to run, the monetary depreciation 
will only be slowed down, not brought to a standstill as a result. 
Once the impetus of the intervention is exhausted, then the 
depreciation resumes again, even more rapidly. However, if the 
increase in notes has actually stopped, no intervention is needed 
to stabilize the mark in terms of gold. 

3. Trend of Depreciation 

In this connection, it is pointed out that the increase in notes 
and the depreciation of the monetary unit do not exactly coincide 
chronologically. The value of the monetary unit often remains 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 17 

almost stable for weeks and even months, while the supply of 
notes increases continually. Then again, commodity prices and 
foreign exchange quotations climb sharply upward, in spite of the 
fact that the current increase in notes is not proceeding any faster 
or may even be slowing down. The explanation for this lies in the 
processes of market operations. The tendency to exaggerate 
every change is inherent in speculation. Should the conduct inau- 
gurated by the few, who rely on their own independent judgment, 
be exaggerated and carried too far by those who follow their lead, 
then a reaction, or at least a standstill, must take place. So igno- 
rance of the principles underlying the formation of monetary 
value leads to a reaction on the market. 

In the course of speculation in stocks and securities, the spec- 
ulator has developed the procedure which is his tool in trade. 
What he learned there he now tries to apply in the field of foreign 
exchange speculations. His experience has been that stocks 
which have dropped sharply on the market usually offer favorable 
investment opportunities and so he believes the situation to be 
similar with respect to the monetary unit. He looks on the mon- 
etary unit as if it were a share of stock in the government. When 
the German mark was quoted in Zurich at 10 francs, one banker 
said: “Now is the time to buy marks. The German economy is 
surely poorer today than before the war so that a lower evaluation 
for the mark is justified. Yet the wealth of the German people has 
certainly not fallen to a twelfth of their prewar assets. Thus, the 
mark must rise in value.” And when the Polish mark had fallen to 
5 francs in Zurich, another banker said: “To me this low price is 
incomprehensible! Poland is a rich country. It has a profitable 
agricultural economy, forests, coal, petroleum. So the rate of 
exchange should be considerably higher.” 

Similarly, in the spring of 1919, a leading official of the 
Hungarian Soviet Republic 12 told me: “Actually, the paper money 
issued by the Hungarian Soviet Republic should have the highest 
rate of exchange, except for that of Russia. Next to the Russian 
government, the Hungarian government, by socializing private 

12 In power from March 21, to August 1, 1919, only. 

18 — The Causes of the Economic Crisis 

property throughout Hungary, has become the richest and thus 
the most credit-worthy in the world.” 

These observers do not understand that the valuation of a 
monetary unit depends not on the wealth of a country, but rather 
on the relationship between the quantity of, and demand for, 
money. Thus, even the richest country can have a bad currency 
and the poorest country a good one. Nevertheless, even though 
the theory of these bankers is false, and must eventually lead to 
losses for all who use it as a guide for action, it can temporarily 
slow down and even put a stop to the decline in the foreign 
exchange value of the monetary unit. 


The Return to Gold 

1. Eminence of Gold 

In the years preceding and during the war, the authors who 
prepared the way for the present monetary chaos were eager to 
sever the connection between the monetary standard and gold. 
So, in place of a standard based directly on gold, it was proposed 
to develop a standard which would promise no more than a con- 
stant exchange ratio in foreign money. These proposals, insofar 
as they aimed at transferring control over the formulation of 
monetary value to government, need not be discussed any fur- 
ther. The reason for using a commodity money is precisely to 
prevent political influence from affecting directly the value of the 
monetary unit. Gold is not the standard money solely on account 
of its brilliance or its physical and chemical characteristics. Gold 
is the standard money primarily because an increase or decrease 
in the available quantity is independent of the orders issued by 
political authorities. The distinctive feature of the gold standard 
is that it makes changes in the quantity of money dependent on 
the profitability of gold production. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 19 

Instead of the gold standard, a monetary standard based on a 
foreign currency could be introduced. The value of the mark 
would then be related, not to gold, but to the value of a specific 
foreign money, at a definite exchange ratio. The Reichsbank 
would be ready at all times to buy or sell marks, in unlimited 
quantities at a fixed exchange rate, against the specified foreign 
money. If the monetary unit chosen as the basis for such a system 
is not on a sound gold standard, the conditions created would be 
absolutely untenable. The purchasing power of the German 
money would then hinge on fluctuations in the purchasing power 
of that foreign money. German policy would have renounced its 
influence on the creation of monetary value for the benefit of the 
policy of a foreign government. Then too, even if the foreign 
money, chosen as the basis for the German monetary unit, were 
on an absolutely sound gold standard at the moment, the possi- 
bility would remain that its tie to gold might be cut at some later 
time. So there is no basis for choosing this roundabout route in 
order to attain a sound monetary system. It is not true that adopt- 
ing the gold standard leads to economic dependence on England, 
gold producers, or some other power. Quite the contrary! As a 
matter of fact, it is the monetary standard which relies on the 
money of a foreign government that deserves the name of a “sub- 
sidiary [dependent] or vassal standard.” 13 

2. Sufficiency of Available Gold 

There are no grounds for saying that there is not enough gold 
available to enable all the countries in the world to have the gold 
standard. There can never be too much, nor too little, gold to 
serve the purpose of money. Supply and demand are brought into 
balance by the formation of prices. Nor is there reason to fear 
that prices generally would be depressed too severely by a return 
to the gold standard on the part of countries with depreciated 
currencies. The world’s gold supplies have not decreased since 
1914. They have increased. In view of the decline in trade and the 

13 Carl A. Schaefer, Klassische Valutastabilisierungen (Hamburg, 1922), 
p. 65. 

20 — The Causes of the Economic Crisis 

increase in poverty, the demand for gold should be lower than it 
was before 1914, even after a complete return to the gold stan- 
dard. After all, a return to the gold standard would not mean a 
return to the actual use of gold money within the country to pay 
for small- and medium-sized transactions. For even the gold 
exchange standard [ Goldkernwahrung ] developed by Ricardo in 
his work, Proposals for an Economical and Secure Currency 
(1816), is a legitimate and adequate gold standard, 14 as the his- 
tory of money in recent decades clearly shows. 

Basing the German monetary system on some foreign money 
instead of the metal gold would have only one significance: By 
obscuring the true nature of reform, it would make a reversal eas- 
ier for inflationist writers and politicians. The first condition of 
any real monetary reform is still to rout completely all populist 
doctrines advocating Chartism, 15 the creation of money, the 
dethronement of gold and free money. Any imperfection and lack 
of clarity here is prejudicial. Inflationists of every variety must be 
completely demolished. We should not be satisfied to settle for 
compromises with them. The slogan, “Down with gold,” must be 
ousted. The solution rests on substituting in its place: “No gov- 
ernmental interference with the value of the monetary unit!” 

14 [By 1928, when Mises wrote “Monetary Stabilization and Cyclical 
Policy,” the second essay in this volume, he had rejected the flexible (gold 
exchange) standard (see below, pp. 60ff.) pointing out that the only hope of 
curbing the powerful political incentives to inflate lay in having a “pure” 
gold coin standard. He “confessed” this shift in views in Human Action (1st 
ed., 1949, p. 780; 2nd and 3rd eds., 1963 and 1966, p. 786; Scholar’s Edition 
1998, p. 780). — Ed.] 

15 Chartism, an English working class movement, arose as a revolt against 
the Poor Law of 1835 which forced those able to work to enter workhouses 
before receiving public support. The movement was endorsed by both 
Marx and Engels and accepted the labor theory of value. Its members 
included those seeking inconvertible paper money and all sorts of political 
interventions and welfare measures. The advocates of various schemes 
were unified only in the advocacy of a charter providing for universal adult 
male suffrage, which each faction thought would lead to the adoption of its 
particular nostrums. Chartists’s attempts to obtain popular support failed 
conspicuously and after 1848 the movement faded away. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 21 


The Money Relation 

1. Victory and Inflation 

No one can any longer maintain seriously that the rate of 
exchange for the German paper mark could be reestablished [in 
1923] at its old gold value — as specified by the legislation of 
December 4, 1871, and by the coinage law of July 9, 1873. Yet 
many still resist the proposal to stabilize the gold value of the 
mark at the currently low rate. Rather vague considerations of 
national pride are often marshaled against it. Deluded by false 
ideas as to the causes of monetary depreciation, people have been 
in the habit of looking on a country’s currency as if it were the 
capital stock of the fatherland and of the government. People 
believe that a low exchange rate for the mark is a reflection of an 
unfavorable judgment as to the political and economic situation 
in Germany. They do not understand that monetary value is 
affected only by changes in the relation between the demand for, 
and quantity of, money and the prevailing opinion with respect 
to expected changes in that relationship, including those pro- 
duced by governmental monetary policies. 

During the course of the war, it was said that “the currency of 
the victor” would turn out to be the best. But war and defeat on 
the field of battle can only influence the formation of monetary 
value indirectly. It is generally expected that a victorious govern- 
ment will be able to stop the use of the printing press sooner. The 
victorious government will find it easier both to restrict its 
expenditures and to obtain credit. This same interpretation 
would also argue that the rate of exchange of the defeated coun- 
try would become more favorable as the prospects for peace 
improved. The values of both the German mark and the Austrian 
crown rose in October 1918. It was thought that a halt to the 
inflation could be expected even in Germany and Austria, but 
obviously this expectation was not fulfilled. 

22 — The Causes of the Economic Crisis 

History shows that the foreign exchange value of the “victor’s 
money” may also be very low. Seldom has there been a more bril- 
liant victory than that finally won by the American rebels under 
Washington’s leadership over the British forces. Yet the 
American money did not benefit as a result. The more proudly 
the Star Spangled Banner was raised, the lower the exchange rate 
fell for the “Continentals,” as the paper notes issued by the rebel- 
lious states were called. Then, just as the rebels’ victory was 
finally won, these “Continentals” became completely worthless. 
A short time later, a similar situation arose in France. In spite of 
the victory achieved by the Revolutionists, the agio [premium] 
for the metal rose higher and higher until finally, in 1796, the 
value of the paper monetary unit went to zero. In each case, the 
victorious government pursued inflation to the end. 

2. Establishing Gold “Ratio” 

It is completely wrong to look on “devaluation” as governmen- 
tal bankruptcy. Stabilization of the present depressed monetary 
value, even if considered only with respect to its effect on the 
existing debts, is something very different from governmental 
bankruptcy. It is both more and, at the same time, less than gov- 
ernmental bankruptcy. It is more than governmental bankruptcy 
to the extent that it affects not only public debts, but also all pri- 
vate debts. It is less than governmental bankruptcy to the extent 
that it affects only the government’s outstanding debts payable in 
paper money, while leaving undisturbed its obligations payable in 
hard money or foreign currency. Then too, monetary stabiliza- 
tion brings with it no change in the relationships among 
contracting parties, with respect to paper money debts already 
contracted without any assurance of an increase in the value of 
the money. 

To compensate the owners of claims to marks for the losses 
suffered, between 1914 and 1923, calls for something other than 
raising the mark’s exchange rate. Debts originating during this 
period would have to be converted by law into obligations 
payable in old gold marks according to the mark’s value at the 
time each obligation was contracted. It is extremely doubtful if 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 23 

the desired goal could be attained even by this means. The pres- 
ent title-holders to claims are not always the same ones who have 
borne the loss. The bulk of claims outstanding are represented by 
securities payable to the bearer and a considerable portion of all 
other claims have changed hands in the course of the years. 
When it comes to determining the currency profits and losses 
over the years, accounting methods are presented with tremen- 
dous obstacles by the technology of trade and the legal structure 
of business. 

The effects of changes in general economic conditions on 
commerce, especially those of every cash-induced change in 
monetary value, and every increase in its purchasing power, mil- 
itate against trying to raise the value of the monetary unit before 
[redefining and] stabilizing it in terms of gold. The value of the 
monetary unit should be [legally defined and] stabilized in terms 
of gold at the rate (ratio) which prevails at the moment. 

As long as monetary depreciation is still going on, it is obvi- 
ously impossible to speak of a specific “rate” for the value of 
money. For changes in the value of the monetary unit do not 
affect all goods and services throughout the whole economy at 
the same time and to the same extent. These changes in mone- 
tary value necessarily work themselves out irregularly and 
step-by-step. It is generally recognized that in the short, or even 
the longer run, a discrepancy may exist between the value of the 
monetary unit, as expressed in the quotation for various foreign 
currencies, and its purchasing power in goods and services on 
the domestic market. 

The quotations on the Bourse for foreign exchange always 
reflect speculative rates in the light of the currently evolving, but 
not yet consummated, change in the purchasing power of the 
monetary unit. However, the monetary depreciation, at an early 
stage of its gradual evolution, has already had its full impact on for- 
eign exchange rates before it is fully expressed in the prices of all 
domestic goods and services. This lag in commodity prices, behind 
the rise of the foreign exchange rates, is of limited duration. In the 
last analysis, the foreign exchange rates are determined by nothing 
more than the anticipated future purchasing power attributed to a 

24 — The Causes of the Economic Crisis 

unit of each currency. The foreign exchange rates must be estab- 
lished at such heights that the purchasing power of the monetary 
unit remains the same, whether it is used to buy commodities 
directly, or whether it is first used to acquire another currency with 
which to buy the commodities. In the long run the rate cannot 
deviate from the ratio determined by its purchasing power. This 
ratio is known as the “natural” or “static” rate . 16 

In order to stabilize the value of a monetary unit at its present 
value, the decline in monetary value must first be brought to a 
stop. The value of the monetary unit in terms of gold must first 
attain some stability. Only then can the relationship of the mone- 
tary unit to gold be given any lasting status. First of all, as pointed 
out above, the progress of inflation must be blocked by halting any 
further increase in the issue of notes. Then one must wait a while 
until after foreign exchange quotations and commodity prices, 
which will fluctuate for a time, have become adjusted. As has 
already been explained, this adjustment would come about not 
only through an increase in commodity prices but also, to some 
extent, with a drop in the foreign exchange rate . 17 

16 [Mises later came to prefer the term “final rate” or the rate that would 
prevail if a “final state of rest,” reflecting the final effects of all changes 
already initiated, were actually reached. See Human Action, chapter XIV, 
section 5.— Ed.] 

17 [For a later elaboration of this position, see Mises’s “Monetary 
Reconstruction” epilogue to the 1953 (and later) editions of The Theory of 
Money and Credit— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 25 


Comments on the “Balance 
of Payments” Doctrine 

1. Refined Quantity Theory of Money 

The generally accepted doctrine maintains that the establish- 
ment of sound relationships among currencies is possible only 
with a “favorable balance of payments.” According to this view, a 
country with an “unfavorable balance of payments” cannot main- 
tain the stability of its monetary value. In this case, the 
deterioration in the rate of exchange is considered structural and 
it is thought it may be effectively counteracted only by eliminat- 
ing the structural defects. 

The answer to this and to similar arguments is inherent in the 
Quantity Theory and in Gresham’s Law. 

The Quantity Theory demonstrated that in a country which 
uses only commodity money, the “purely metallic currency” stan- 
dard of the Currency Theory, money can never flow abroad 
continuously for any length of time. The outflow of a part of the 
gold supply brings about a contraction in the quantity of money 
available in the domestic market. This reduces commodity 
prices, promotes exports and restricts imports, until the quantity 
of money in the domestic economy is replenished from abroad. 
The precious metals being used as money are dispersed among 
the various individual enterprises and thus among the several 
national economies, according to the extent and intensity of their 
respective demands for money. Governmental interventions, 
which seek to regulate international monetary movements in 
order to assure the economy a “needed” quantity of money, are 

The undesirable outflow of money must always be simply the 
result of a governmental intervention which has endowed differ- 
ently valued moneys with the same legal purchasing power. All 

26 — The Causes of the Economic Crisis 

that the government need do to avoid disrupting the monetary 
situation, and all it can do, is to abandon such interventions. That 
is the essence of the monetary theory of Classical economics and 
of those who follow in its footsteps, the theoreticians of the 
Currency School . 18 

With the help of modern subjective theory, this theory can be 
more thoroughly developed and refined. Still it cannot be demol- 
ished. And no other theory can be put in its place. Those who can 
ignore this theory only demonstrate that they are not econo- 

2. Purchasing Power Parity 

One frequently hears, when commodity money is being 
replaced in one country by credit or token money — because the 
legally-decreed equality between the over-issued paper and the 
metallic money has prompted the sequence of events described 
by Gresham’s Law — that it is the balance of payments that deter- 
mines the rates of foreign exchange. That is completely wrong. 
Exchange rates are determined by the relative purchasing power 
per unit of each kind of money. As pointed out above, exchange 
rates must eventually be established at a height at which it makes 
no difference whether one uses a piece of money directly to buy 
a commodity, or whether one first exchanges this money for units 
of a foreign currency and then spends that foreign currency for 
the desired commodity. Should the rate deviate from that deter- 
mined by the purchasing power parity, which is known as the 
“natural” or “static” rate, an opportunity would emerge for under- 
taking profit-making ventures. 

It would then be profitable to buy commodities with the 
money which is legally undervalued on the exchange, as com- 
pared with its purchasing power parity, and to sell those 
commodities for that money which is legally overvalued on the 
exchange, as compared with its actual purchasing power. 
Whenever such opportunities for profit exist, buyers would 

18 [See Mises’s The Theory of Money and Credit, pp. 180-86; 1980, pp. 
207-13.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 27 

appear on the foreign exchange market with a demand for the 
undervalued money. This demand drives the exchange up until it 
reaches its “final rate .” 19 Foreign exchange rates rise because the 
quantity of the [domestic] money has increased and commodity 
prices have risen. As has already been explained, it is only 
because of market technicalities that this cause and effect rela- 
tionship is not revealed in the early course of events as well. 
Under the influence of speculation, the configuration of foreign 
exchange rates on the Bourse forecasts anticipated future 
changes in commodity prices. 

The balance of payments doctrine overlooks the fact that the 
extent of foreign trade depends entirely on prices. It disregards 
the fact that nothing can be imported or exported if price differ- 
ences, which make the trade profitable, do not exist. The balance 
of payments doctrine derives from superficialities. Anyone who 
simply looks at what is taking place on the Bourse every day and 
every hour sees, to be sure, only that the momentary state of the 
balance of payments is decisive for supply and demand on the 
foreign exchange market. Yet this diagnosis is merely the start of 
the inquiry into the factors determining foreign exchange rates. 
The next question is: What determines the momentary state of 
the balance of payments? This must lead only to the conclusion 
that the balance of payments is determined by the structure of 
prices and by the sales and purchases inspired by differences in 

3. Foreign Exchange Rates 

With rising foreign exchange quotations, foreign commodities 
can be imported only if they find buyers at their higher prices. 
One version of the balance of payments doctrine seeks to distin- 
guish between the importation of necessities of life and articles 

19 See my paper “Zahlungsbilanz und Valutenkurse,” Mitteilungen des 
Verbandes osterreichischer Banken und Bankiers II (1919): 39ff. [NOTE: 
Pertinent excerpts from this explanation of the “balance of payments” fal- 
lacy have been translated and appear here in the Appendix, pp. 44-51. See 
also Human Action, 1966, pp. 450-58; 1998, pp. 447-55.— Ed.] 

28 — The Causes of the Economic Crisis 

which are considered less vital or necessary. It is thought that the 
necessities of life must be obtained at any price, because it is 
absolutely impossible to get along without them. As a result, it is 
held that a country’s foreign exchange must deteriorate continu- 
ously if it must import vitally-needed commodities while it can 
export only less-necessary items. This reasoning ignores the fact 
that the greater or lesser need for certain goods, the size and 
intensity of the demand for them, or the ability to get along with- 
out them, is already fully expressed by the relative height of the 
prices assigned to the various goods on the market. 

No matter how strong a desire the Austrians may have for for- 
eign bread, meat, coal or sugar, they can satisfy this desire only if 
they can pay for them. If they want to import more, they must 
export more. If they cannot export more manufactured, or semi- 
manufactured, goods, they must export shares of stock, bonds, 
and titles to property of various kinds. 

If the quantity of notes were not increased, then the prices of 
the items for sale would be lower. If they then demand more 
imported goods, the prices of these imported items must rise. Or 
else the rise in the prices of vital necessities must be offset by a 
decline in the prices of less vital articles, the purchase of which is 
restricted to permit the purchase of more necessities. Thus a 
general rise in prices is out of the question [without an increase 
in the quantity of notes]. The international payments would 
come into balance either with an increase in the export of dispen- 
sable goods or with the export of securities and similar items. It 
is only because the quantity of notes has been increased that they 
can maintain their imports at the higher exchange rates without 
increasing their exports. This is the only reason that the increase 
in the rate of exchange does not completely choke off imports 
and encourage exports until the “balance of payments” is once 
again “favorable .” 20 

20 From the tremendous literature on the subject, I will mention here only 
T.E. Gregory’s Foreign Exchange Before, During and After the War (London, 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 29 

Certainly no proof is needed to demonstrate that speculation 
is not responsible for the deterioration of the foreign exchange 
situation. The foreign exchange speculator tries to anticipate 
prospective fluctuations in rates. He may perhaps blunder. In that 
case he must pay for his mistakes. However, speculators can 
never maintain for any length of time a quotation which is not in 
accord with market ratios. Governments and politicians, who 
blame the deterioration of the currency on speculation, know 
this very well. If they thought differently with respect to future 
foreign exchange rates, they could speculate for the government’s 
account, against a rise and in anticipation of a decline. By this sin- 
gle act they could not only improve the foreign exchange rate, but 
also reap a handsome profit for the Treasury. 

4. Foreign Exchange Regulations 

The ancient Mercantilist fallacies paint a specter which we 
have no cause to fear. No people, not even the poorest, need 
abandon sound monetary policy. It is neither the poverty of the 
individual nor of the group, it is neither foreign indebtedness nor 
unfavorable conditions of production, that drives foreign 
exchange rates way up. Only inflation does this. 

Consequently, every other means employed in the struggle 
against the rise in foreign exchange rates is useless. If the infla- 
tion continues, they will be ineffective. If there is no inflation, 
they are superfluous. The most significant of these other means 
is the prohibition or, at least, the restriction of the importation 
of certain goods which are considered dispensable, or at least 
not vitally necessary. The sums of money within the country 
which would have been spent for the purchase of these goods are 
now used for other purchases. Obviously, the only goods 
involved are those which would otherwise have been sold 
abroad. These goods are now bought by residents within the 
country at prices higher than those bid for them by foreigners. 
As a result, on the one side there is a decline in imports and thus 
in the demand for foreign exchange, while on the other side 
there is an equally large reduction in exports and thus also a 
decline in the supply of foreign exchange. Imports are paid for 

30 — The Causes of the Economic Crisis 

by exports, not with money as the superficial Neo-mercantilist 
doctrine still maintains. 

If one really wants to check the demand for foreign exchange, 
then, to the extent that one wants to reduce imports, money 
must actually be taken away from the people — perhaps through 
taxes. This sum should be completely withdrawn from circula- 
tion, not even given out for government purposes, but rather 
destroyed. This means adopting a policy of deflation. Instead of 
restricting the importation of chocolate, wine and cigarettes, the 
sums people would have spent for these commodities must be 
taken away from them. The people would then either have to 
reduce their consumption of these or of some other commodi- 
ties. In the former case [i.e., if the consumption of imported 
goods is reduced] less foreign exchange is sought. In the latter 
case [i.e., if the consumption of domestic articles declines] more 
goods are exported and thus more foreign exchange becomes 

It is equally impossible to influence the foreign exchange mar- 
ket by prohibiting the hoarding of foreign moneys. If the people 
mistrust the reliability of the value of the notes, they will seek to 
invest a portion of their cash holdings in foreign money. If this is 
made impossible, then the people will either sell fewer commodi- 
ties and stocks or they will buy more commodities, stocks, and 
the like. However, they will certainly not hold more domestic 
currency in place of foreign exchange. In any case, this behavior 
reduces total exports. The demand for foreign exchange for 
hoarding disappears and, at the same time, the supply of foreign 
exchange coming into the country in payment of exports 
declines. Incidentally, it may be mentioned that making it more 
difficult to amass foreign exchange hampers the accumulation of 
a reserve fund that could help the economy weather the critical 
time which immediately follows the collapse of a paper monetary 
standard. As a matter of fact, this policy could eventually lead to 
even more serious trouble. 

It is entirely incomprehensible how the idea originates that 
making the export of one’s own notes more difficult is an appro- 
priate method for reducing the foreign exchange rate. If fewer 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 31 

notes leave the country, then more commodities must be 
exported or fewer imported. The quotation for notes on 
exchange markets abroad does not depend on the greater or 
lesser supplies of notes available there. Rather, it depends on 
commodity prices. The fact that foreign speculators buy up notes 
and hoard them, leading to a speculative boom, is only likely to 
raise their quoted price. If the sums held by foreign speculators 
had remained within the country, the domestic commodity 
prices and, as a result, the “final rate” of foreign exchange would 
have been driven up still higher. 

If inflation continues, neither foreign exchange regulations 
nor control of foreign exchange clearings can stop the deprecia- 
tion of the monetary unit abroad. 


The Inflationist Argument 

1. Substitute for Taxes 

Nowadays, the thesis is maintained that sound monetary rela- 
tionships may certainly be worth striving for, but public policy is 
said to have other higher and more important goals. As serious 
an evil as inflation is, it is not considered the most serious. If it is 
a choice of protecting the homeland from enemies, feeding the 
starving and keeping the country from destruction, then let the 
currency go to rack and ruin. And if the German people must pay 
off a tremendous war debt, then the only way they can help them- 
selves is through inflation. 

This line of reasoning in favor of inflationism must be sharply 
distinguished from the old inflationist argument which actually 
approved of the economic consequences of continual monetary 
depreciation and considered inflationism a worthwhile political 
goal. According to the later doctrine, inflationism is still consid- 
ered an evil although, under certain circumstances, a lesser evil. 

32 — The Causes of the Economic Crisis 

In its eyes, monetary depreciation is not considered the 
inevitable outcome of a certain pattern of economic conditions, 
as it is by adherents of the “balance of payments” doctrine dis- 
cussed in the preceding section. Advocates of limited 
inflationism tacitly, if not openly, admit in their argumentation 
that paper money inflation, as well as the resulting monetary 
depreciation, is always a product of inflationist policy. However, 
they believe that a government may get into a situation in which 
it would be more advantageous to counter a greater evil with the 
lesser evil of inflationism. 

The argument for limited inflationism is often stated so as to 
represent inflationism as a kind of a tax which is called for under 
certain conditions. In some situations it is considered more 
advantageous to cover government expenditures by issuing new 
notes, than by increasing the burden of taxes or borrowing 
money. This was the argument during the war, when it was a 
question of defraying the expenses of the army and navy. The 
same argument is now advanced when it comes to supplying 
some of the population with cheap foodstuffs, covering the oper- 
ating deficits of public enterprises (the railroads, etc.) and 
arranging for reparations payments. The truth is that inflation- 
ism is resorted to when raising taxes is considered disagreeable 
and when borrowing is considered impossible. The question now 
is to explore the reasons why it is considered disagreeable or 
impossible to employ these two normally routine ways of obtain- 
ing money for government expenditures. 

2. Financing Unpopular Expenditures 

High taxes can be imposed only if the general public is in 
agreement with the purposes for which the funds collected will 
be used. In this connection, it is worth noting that the higher the 
general burden of taxes, the more difficult it becomes to deceive 
public opinion as to the fact that the taxes cannot be borne by 
the more affluent minority of the population alone. Even taxes 
levied on property owners and the more affluent affect the entire 
economy. Their indirect effects on the less well-to-do are often 
felt more intensely than would be those from direct proportional 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 33 

taxation. It may not be easy to detect these relationships when 
tax rates are relatively low, but they can hardly be overlooked 
when taxes are higher. However, there is no doubt that the pres- 
ent system of taxing “property” can hardly be carried any farther 
than it already has been in the countries where inflationism now 
prevails. Thus the decision will have to be made to rely more 
directly on the masses for providing funds. For policy makers 
who enjoy the confidence of the masses only if they impose no 
obvious sacrifice, this is something they dare not risk. 

Can anyone doubt that the warring peoples of Europe would 
have tired of the conflict much sooner, if their governments had 
clearly, candidly, and promptly, presented them with the bill for 
military expenses? No war party in any European country would 
have dared to levy any considerable taxes on the masses to pay 
the costs of the war. Even in England, the printing presses were 
set in motion. Inflation had the great advantage of creating an 
appearance of economic well-being, of an increase of wealth. It 
also concealed capital consumption by falsifying monetary calcu- 
lations. The inflation led to illusory entrepreneurial and 
capitalistic profits, which could be taxed as income at especially 
high rates. This could be done without the masses, and fre- 
quently even without the taxpayers themselves, noticing that a 
portion of capital itself was being taxed away. Inflation made it 
possible to turn the anger of the people against “war profiteers, 
speculators and smugglers.” Thus, inflation proved itself an excel- 
lent psychological aid to the pro-war policy, leading to 
destruction and annihilation. 

What the war began, the revolution continues. A socialistic or 
semi-socialistic government needs money to operate unprof- 
itable enterprises, to subsidize the unemployed and to provide 
the people with cheap food supplies. Yet, it cannot raise the funds 
through taxes. It dares not tell the people the truth. The pro-sta- 
tist, pro-socialist doctrine calling for government operation of 
the railroads would lose its popularity very quickly if a special tax 
were levied to cover the operating losses of the government rail- 
roads. If the Austrian masses themselves had been asked to pay a 

34 — The Causes of the Economic Crisis 

special bread tax, they would very soon have realized from 
whence came the funds to make the bread cheaper. 

3. War Reparations 

The decisive factor for the German economy is obviously the 
payment of the reparations burden imposed by the Treaty of 
Versailles and its supplementary agreements. According to Karl 
Helfferich, 21 these payments imposed on the German people an 
annual obligation estimated at two-thirds of their national income. 
This figure is undoubtedly much too high. No doubt, other 
estimates, especially those pronounced by French observers, con- 
siderably underestimate the actual ratio. In any event, the fact 
remains that a very sizeable portion of Germany’s current income 
is consumed by the levy imposed on the nation, and that, if the 
specified sum is to be withdrawn every year from income, the liv- 
ing standard of the German people must be substantially reduced. 

Even though somewhat hampered by the remnants of feudal- 
ism, an authoritarian constitution and the rise of statism and 
socialism, capitalism was able to develop to a considerable extent 
on German soil. In recent generations, the capitalistic economic 
system has multiplied German wealth many times over. In 1914, 
the German economy could support three times as many people 
as a hundred years earlier and still offer them incomparably more. 
The war and its immediate consequences have drastically reduced 
the living standards of the German people. Socialistic destruction 
has continued this process of impoverishment. Even if the 
German people did not have to fulfill any reparations payments, 
they would still be much, much poorer than they were before the 
war. The burden of these obligations must inevitably reduce their 
living standard still further — to that of the thirties and forties of 
the last century. It may be hoped that this impoverishment will 

21 I<arl Helfferich, Die Politik der Erfiillung (Munich, 1922), p. 22. 
[NOTE: Helfferich (1872-1924), as Minister of the German Imperial 
Treasury, 1915-1916, and later in various official and unofficial capaci- 
ties, was instrumental in promoting inflation and opposing reparations 
payments.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 35 

lead to a reexamination of the socialist ideology which dominates 
the German spirit today, that this will succeed in removing the 
obstacles now preventing an increase in productivity, and that the 
unlimited opening up of possibilities for development, which exist 
under capitalism and only under capitalism, will increase many 
times over the output of German labor. Still the fact remains that 
if the obligation assumed is to be paid for out of income, the only 
way is to produce more and consume less. 

A part of the burden, or even all of it, could of course be paid 
off by the export of capital goods. Shares of stock, bonds , 22 busi- 
ness assets, land, buildings, would have to be transferred from 
German to foreign ownership. This would also reduce the total 
income of the people in the future, if not right away. 

4. The Alternatives 

These various means, however, are the only ways by which the 
reparations obligations can be met. Goods or capital, which 
would otherwise have been consumed within the country, can be 
exported. To discuss which is more practical is not the task of this 
essay. The only question which concerns us is how the govern- 
ment can proceed in order to shift to the individual citizens the 
burden of payments, which devolves first of all on the German 
treasury. Three ways are possible: raising taxes; borrowing within 
the country; and issuing paper money. Whichever one of the 
three methods may be chosen, the nature of its effect abroad 
remains unaltered. These three ways differ only in their distribu- 
tion of the burden among citizens. 

If the funds are collected by raising a domestic loan, then sub- 
scribers to the loan must either reduce their consumption or 
dispose of a part of their capital. If taxes are imposed, then the 
taxpayers must do the same. The funds which flow from taxes or 
loans into the government treasury and which it uses to buy gold, 
foreign bills of exchange and foreign currencies to fulfill its for- 
eign liabilities, are supplied by the lenders and the taxpayers 

22 Thus, raising a foreign loan falls within this category too. 

36 — The Causes of the Economic Crisis 

through the sale abroad of commodities and capital goods. The 
government can only purchase available foreign exchange which 
comes into the country from these sales. So long as the govern- 
ment has the power to distribute only those funds which it 
receives from tax payments and the floating of loans, its pur- 
chases of foreign exchange cannot push up the price of gold and 
foreign currencies. At any one time, the government can buy only 
so much gold and foreign exchange as the citizens have acquired 
through export sales. In fact, the world prices of goods and serv- 
ices cannot rise on this account. Rather their prices will decline 
as a consequence of the larger quantities offered for sale. 

However, if and as the government follows the third route, 
issuing new notes in order to buy gold and foreign exchange 
instead of raising taxes and floating loans, then its demand for 
gold and foreign exchange, which is obviously not counterbal- 
anced by a proportionate supply, drives up the prices of various 
kinds of foreign money. It then becomes advantageous for for- 
eigners to acquire more marks so as to buy capital goods and 
commodities within Germany at prices which do not yet reflect 
the new ratios. These purchases drive prices up in Germany right 
away and bring them once again into adjustment with the world 
market. This is the actual situation. The foreign exchange, with 
which reparations obligations are paid, comes from sales abroad 
of German capital and commodities. The only difference consists 
in how the government obtains the foreign exchange. In this case, 
the government first buys the foreign exchange abroad with 
marks, which the foreigners then use to make purchases in 
Germany, rather than the German government’s acquiring the 
foreign exchange from those within Germany who have received 
payment for previous sales abroad. 

From this one learns that the continuing depreciation of the 
German mark cannot be the consequence of reparations pay- 
ments. The depreciation of the mark is simply a result of the fact 
that the government supplies the funds needed for the payments 
through new issues of notes. Even those who wish to attribute the 
decline in the rate of exchange on the market to the payment of 
reparations, rather than to inflation, point out that the quotation 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 37 

for marks is inevitably disturbed by the government’s offering of 
marks for the purchase of foreign exchange . 23 Still, if the govern- 
ment had available for these foreign exchange purchases only the 
number of marks which it received from taxes or loans, then its 
demand would not exceed the supply. It is only because it is offer- 
ing newly created notes, that it drives the foreign exchange rates 

5. The Government’s Dilemma 

Nevertheless, this is the only method available for the German 
government to defray the reparations debt. Should it try to raise the 
sums demanded through loans or taxes, it would fail. As conditions 
with the German people are now, if the economic consequences of 
compliance were clearly understood and there was no deception as 
to the costs of that policy, the government could not count on 
majority support for it. Public opinion would turn with tremendous 
force against any government that tried to carry out in full the obli- 
gations to the Allied Powers. It is not our task to explore whether or 
not that might be a wise policy. 

However, saying that the decline of the value of the German 
mark is not the direct consequence of making reparations pay- 
ments but is due rather to the methods the German government 
uses to collect the funds for the payments, by no means has the 
significance attached to it by the French and other foreign politi- 
cians. They maintain that it is justifiable, from the point of view 
of world policy, to burden the German people with this heavy 
load. This explanation of the German monetary depreciation has 
absolutely nothing to do with whether, in view of the terms of the 
Armistice, the Allied demand, in general, and its height, in par- 
ticular, are founded on justice. 

23 See Walter Rathenau’s addresses— January 12, 1922, before the Senate of 
the Allied Powers at Cannes, and March 29, 1922, to the Reichstag (Cannes 
und Genua, Vier Reden zum Reparationsproblem [Berlin 1922], pp. llff. and 
34ff.j. [NOTE: Rathenau (1867-1922), a German industrialist, became an 
official in the post-World War I German government — Minister of 
Reconstruction (1921) and Foreign Minister (1922). — Ed.] 

38 — The Causes of the Economic Crisis 

The only significant thing for us, however, since it explains the 
political role of the inflationist procedure, is yet another insight. 
We have seen that if a government is not in a position to negotiate 
loans and does not dare levy additional taxation for fear that the 
financial and general economic effects will be revealed too clearly 
too soon, so that it will lose support for its program, it always con- 
siders it necessary to undertake inflationary measures. Thus 
inflation becomes one of the most important psychological aids to 
an economic policy which tries to camouflage its effects. In this 
sense, it may be described as a tool of antidemocratic policy. By 
deceiving public opinion, it permits a system of government to 
continue which would have no hope of receiving the approval of 
the people if conditions were frankly explained to them. 

Inflationist policy is never the necessary consequence of a 
specific economic situation. It is always the product of human 
action — of man-made policy. For whatever the reason, the quan- 
tity of money in circulation is increased. It may be that the people 
are influenced by incorrect theoretical doctrines as to the way the 
value of money develops and are not aware of the consequences 
of this action. It may be that, in full knowledge of the effects of 
inflation, they are purposely aiming, for some reason, at a reduc- 
tion in the value of the monetary unit. So no apology can ever be 
given for inflationist policy. If it rests on theoretically incorrect 
monetary doctrines, then it is inexcusable, for there should never, 
never be any forgiveness for wrong theories. If it rests on a defi- 
nite judgment as to the effects of monetary depreciation, then to 
want to “excuse it” is inconsistent. If monetary depreciation has 
been knowingly engineered, its advocates would not want to 
excuse it but rather to try to demonstrate that it was a good pol- 
icy. They would want to show that, under the circumstances, it 
was even better to depreciate the money than to raise taxes fur- 
ther or to permit the deficit-ridden, nationalized railroads to be 
transferred from government control to private hands. 

Even governments must learn once more to adjust their outgo 
to income. Once the end results to which inflation must lead are 
recognized, the thesis, that a government is justified in issuing 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 39 

notes to make up for its lack of funds, will disappear from the 
handbooks of political strategy. 


The New Monetary System 

1. First Steps 

The bedrock and cornerstone of the provisional new mone- 
tary system must be the absolute prohibition of the issue of any 
additional notes not completely covered by gold. The maximum 
limit for German notes in circulation [not completely covered by 
gold] will be the sum of the banknotes, Loan Bureau Notes 
( Darlehenskassenscheinen ), emergency currency ( Notgeld ) of 
every kind, and small coins, actually in circulation at the instant 
of the monetary reform, less the gold stock and supply of foreign 
bills held in the reserves of the Reichsbank and the private banks 
of issue. There must be absolutely no expansion above this max- 
imum under any circumstances, except for the relaxation 
mentioned above at the end of each quarter. [See above pp. 
29-30.] Notes of any kind over and above this amount must be 
fully covered by deposits of gold or foreign exchange in the 
Reichsbank. As may be seen, this constitutes acceptance of the 
leading principle of Peel’s Bank Act, with all its shortcomings. 
However, these flaws have little significance at the moment. Our 
first concern is only to get rid of the inflation by stopping the 
printing presses. This goal, the only immediate one, will be most 
effectively served by a strict prohibition of the issue of additional 
notes not backed by metal. 

Once adjustments have been made to the new situation, then 
it will be time enough to consider: 

(1) On the one hand, whether it might not perhaps be expe- 
dient to tolerate the issue, within very narrow limits, of 
notes not covered by metal. 

40 — The Causes of the Economic Crisis 

(2) On the other hand, whether it might not also be neces- 
sary to limit similarly the issue of other fiduciary media 
by establishing regulations over the banks’ cash balances 
and their check and draft transactions. 

The question of banking freedom must then be discussed, 
again and again, on basic principles. Still, all this can wait until 
later. What is needed now is only to prohibit the issue of addi- 
tional notes not covered by metal. This is all that can be done at 
present. Ideally, the limitation on the issue of currency could also 
be extended, even now, to the Reichsbank’s transfer balances 
(deposits). 24 However, this is not of as critical importance, for the 
present currency inflation has been and can be brought about 
only by the issue of notes. 

Simultaneously with the enactment of the prohibition against 
the issue of additional notes not covered by metal, the Reichsbank 
should be required to purchase all supplies of gold offered them in 
exchange for notes at prices precisely corresponding to the new 
ratio. At the same time, the Reichsbank should be obliged to supply 
any amount of gold requested at that ratio, to anyone able to offer 
German notes in payment. With this reform, the German standard 
would become a gold exchange standard (Goldkernwahrung). Later 
will be time enough to examine whether or not to renounce perma- 
nently the actual circulation of gold within the country. Careful 
consideration should be given to whether or not the higher costs 
needed to maintain the actual circulation of gold within the coun- 
try might not be amply repaid by the fact that this would permit the 
people to discontinue using notes. Weaning the people away from 
paper money could perhaps forestall future efforts aimed at the 
over-issue of notes endowed with legal tender status. Nevertheless, 
the gold exchange standard is undoubtedly sufficient for the time 

24 See p. 26 above. [NOTE: The German term is “Giroguthaben.” In 
Germany the “giro” banking system prevailed whereby depositors, instead 
of writing checks, authorized their banks to transfer specified sums to the 
accounts they wished paid.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 41 

being . 25 The legal rate for notes in making payments can be tem- 
porarily maintained without risk. 

It should also be specifically pointed out that the obligation 
of the Reichsbank to redeem its notes must be interpreted in 
the strictest possible manner. Every subterfuge, by which 
European central banks sought to follow some form of “gold 
premium policy ” 26 during the decades preceding the World 
War, must be discontinued. 

2. Market Interest Rates 

If the Reichsbank were operating under these principles, it 
would obviously not be in a position to supply the money market 
with funds obtained by increasing the circulation of notes not 
covered by metal. Except for the possibilities of such transfers as 
may not have been previously limited, the Bank will be able to 
lend out only its own resources and funds furnished by its credi- 
tors. Inflationary increases in the note circulation for the benefit 
of private, as well as public, credit demands will thus be ruled 
out. The Bank will not then be in a position to follow the policy — 
which it has attempted again and again — of lowering artificially 
the market rate of interest. 

The explanation of the balance of payments doctrine pre- 
sented here shows that under this arrangement the Reichsbank 
would not run the risk of an outflow of its gold and foreign 

25 [In view of Mises’s comments here, it appears that he then intended 
that the Reichsbank redeem at this point only larger sums of marks in gold 
and foreign exchange. Mises’s insistence in later years on a gold coin stan- 
dard, with gold coins in daily use, even in the early stages of monetary 
reform, represents a significant refinement of these earlier recommenda- 
tions. See Human Action, chapter XXXI, section 3, and his 1953 essay, 
“Monetary Reconstruction,” the Epilogue to The Theory of Money and 
Credit, 1953, pp. 448-52; 1980, pp. 490-95. Also above, p. 20, note 14.— Ed.] 

26 [In The Theory of Money and Credit (1953, pp. 377ff.; 1980, pp. 416ff.), 
Mises describes the “gold premium policy” of making it difficult and expen- 
sive to obtain gold— by hampering its export through the manipulation of 
discount rates and by limiting the redemption of domestic money in gold. 

42 — The Causes of the Economic Crisis 

exchange ( Devisen ) holdings. Citizens lacking confidence in 
future banking policy, who in the early years of the new monetary 
system try to exchange notes for gold or foreign exchange 
{Devisen), will not be satisfied with the assertion that the Bank 
will be required to redeem its notes only in larger sums, for gold 
bars and foreign exchange, not for gold coins. Then it will not be 
possible to eliminate all notes from circulation. In the beginning 
a larger amount [of foreign currencies and metallic money] may 
even be withdrawn from the Bank and hoarded. However, as 
soon as some confidence in the reliability of the new money 
develops, the hoards of foreign moneys and gold accumulated 
will flow into the Bank. 

The Reichsbank must renounce every attempt to lower inter- 
est rates below those which reflect the actual supply and demand 
relationships existing in the capital markets, and thus encourage 
the demand for loans which can only be made by increasing the 
quantity of notes. This prerequisite for monetary reform will 
evoke the criticism of the naive inflationists of the business 
world. These criticisms will grow as the difficulties of providing 
credit for the German economy increase during the coming 
years. In the view of the businessman, the role of the central bank 
of issue is to provide cheap credit. The businessman believes that 
the Bank should not deny newly created notes to those who want 
additional credit. For decades, the errors of the English Banking 
School theoreticians have prevailed in Germany. Bendixen has 
recently made them popular through his easily readable Theorie 
der klassischen Geldschopfung . 27 

People keep forgetting that the increase in the cost of credit — 
which has become known by the very misleading term, “scarcity 
of money” — cannot be overcome in the long run by inflationist 
measures. They also forget that the interest rate cannot be 
reduced in the long run by credit expansion. The expansion of 
credit always leads to higher commodity prices and quotations 
for foreign exchange and foreign moneys. 

27 [Apparently works of Friedrich Bendixen (1864-1920) are not available 
in English language translations.— Ed.] 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 43 


The Ideological Meaning of Reform 

1. The Ideological Conflict 

The purely materialistic doctrine now used to explain every 
event looks on monetary depreciation as a phenomenon brought 
about by certain “material” causes. Attempts are made to coun- 
teract these imagined causes by various monetary techniques. 
People ignore, perhaps knowingly, that the roots of monetary 
depreciation are ideological in nature. It is always an inflationist 
policy, not “economic conditions,” which brings about the mone- 
tary depreciation. The evil is philosophical in character. The state 
of affairs, universally deplored today, was created by a misunder- 
standing of the nature of money and an incorrect judgment as to 
the consequences of monetary depreciation. 

Inflationism, however, is not an isolated phenomenon. It is 
only one piece in the total framework of politico-economic and 
socio-philosophical ideas of our time. Just as the sound money 
policy of gold standard advocates went hand in hand with liber- 
alism, free trade, capitalism and peace, so is inflationism part and 
parcel of imperialism, militarism, protectionism, statism and 
socialism. 28 Just as the world catastrophe, which has swept over 
mankind since 1914, is not a natural phenomenon but the neces- 
sary outcome of the ideas which dominate our time, so also is the 
monetary crisis nothing but the inevitable consequence of the 
supremacy of certain ideologies concerning monetary policy. 

Statist Theory has tried to explain every social phenomenon 
by the operation of mysterious power factors. It has disputed 
the possibility that economic laws for the formation of prices 
could be demonstrated. Failing to recognize the significance of 

28 [In his later works, Mises would have covered all these ideas, except 
'socialism,” with the terms “interventionism” or “hampered market.” — Ed.] 

44 — The Causes of the Economic Crisis 

commodity prices for the development of exchange relationships 
among various moneys, it has tried to distinguish between the 
domestic and foreign values of money. It has tried to attribute 
changes in exchange rates to various causes — the balance of pay- 
ments, speculative activity, and political factors. Ignoring 
completely the Currency Theory’s important criticism of the 
Banking Theory, Statist Theory has actually prescribed the 
Banking Theory. It has moreover even revived the doctrine of the 
canonists and of the legal authorities of the Middle Ages to the 
effect that money is a creature of the government and the legal 
order. Thus, Statist Theory prepared the philosophical ground- 
work from which the inflationism of recent years developed. 

The belief that a sound monetary system can once again be 
attained without making substantial changes in economic policy 
is a serious error. What is needed first and foremost is to 
renounce all inflationist fallacies. This renunciation cannot last, 
however, if it is not firmly grounded on a full and complete 
divorce of ideology from all imperialist, militarist, protectionist, 
statist, and socialist ideas. 


Balance of Payments 
and Foreign Exchange Rates 29 

The printing press played an important role in creating the 
means for carrying on the war. Every belligerent nation and many 
neutral ones used it. With the cessation of hostilities, however, no 
halt was called to the money-creating activities of the banks of 
issue. Previously, notes were printed to finance the war. Today, 

29 Originally published as “Zahlungsbilanz und Devisenkurse” in 
Mitteilungen des Verbandes Oesterreichischer Banken und Bankiers 2, nos. 
3-4 (1919). This translated excerpt represents about one-third of the orig- 
inal article. 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 45 

notes are still being printed, at least in some countries, to satisfy 
domestic demands of various kinds. The entire world is under 
the sway of inflation. The prices of all goods and services rise 
from day to day and no one can say when these increases will 
come to an end. 

Inflation today is a general phenomenon, but its magnitude is 
not the same in every country. The increase in the quantity of 
money in the different currency areas is neither equal statisti- 
cally — an equality which, given the different demands for money 
in the different areas, would be apparent only — nor has the 
increase proceeded in all areas in the same ratio to the demand for 
money. Thus, price increases, insofar as they are due to changes 
from the money side, have not been the same everywhere. . . . 

Price increases, which are called into existence by an increase in 
the quantity of money, do not appear overnight. A certain amount 
of time passes before they appear. The additional quantity of 
money enters the economy at a certain point. It is only from there, 
step by step, that it is dispersed. It goes first to certain individuals 
in the economy only and to certain branches of production. As a 
result, in the beginning it raises the demand for certain goods and 
services only, not for all of them. Only later do the prices of other 
goods and services also rise. Foreign exchange quotations, how- 
ever, are speculative rates of exchange — that is, they arise out of the 
transactions of business people, who, in their operations, consider 
not only the present but also potential future developments. Thus, 
the depreciation of the money becomes apparent relatively soon in 
the foreign exchange quotations on the Bourse — long before the 
prices of other goods and services are affected. . . . 

Now, there is one theory which seeks to explain the formation 
of foreign exchange rates by the balance of payments, rather than 
by a currency’s purchasing power. This theory makes a distinction 
in the depreciation of the money between the decline in the cur- 
rency’s value on international markets and the reduction in its 
purchasing power domestically. It maintains that there is only a 
very slight connection between the two or, as many say, no con- 
nection at all. The exchange rate of foreign currencies is a result 
of the momentary balance of payments. If the payments going 

46 — The Causes of the Economic Crisis 

abroad rise without a corresponding increase in the payments 
coming into the country, or if the payments coming from abroad 
should decline without a corresponding reduction of the pay- 
ments going out of the country, then foreign exchange rates must 

We shall not speculate on the reasons why such a theory can 
be advanced. Between the change in the exchange rates for for- 
eign currencies and the change in the monetary unit’s domestic 
purchasing power, there is usually a time lag — shorter or longer. 
Therefore, superficial observation could very easily lead to the 
conclusion that the two data were independent of one another. 
We have also heard that the balance of payments is the immedi- 
ate cause of the daily fluctuations in exchange rates. A theory 
which explained surface appearances only and did not analyze 
the situation thoroughly could easily overlook the facts that (a) 
the day-to-day ratio between the supply of and demand for for- 
eign exchange determined by the balance of payments can evoke 
only transitory variations from the “static” rate formed by the 
purchasing power of various kinds of money, (b) these deviations 
must disappear promptly, and (c) these variations will vanish 
more quickly and more completely the less restraints are 
imposed on trade and the freer speculation is. 

Certainly there shouldn’t be any reason to examine this the- 
ory further. It has been settled scientifically. The fact that it 
plays a significant role in economic policy may be a reason for 
investigating the political basis for its undoubted popularity 
among government officials and writers. Still that may be left to 

However, we must concern ourselves with a new variety of this 
balance of payments doctrine which originated with the war. 
People say it may be generally true that the purchasing power of 
the money, rather than the balance of payments, determines the 
exchange rate of foreign currencies. But now, in view of the reduc- 
tion of trade brought about by the war, this is not the case. Since 
trade is hampered, the process which would restore the disrupted 
“static” exchange ratios among foreign currencies is held in check. 
As a result, therefore, the balance of payments becomes decisive 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 47 

for the exchange rates of foreign currencies . 30 If it is desired to raise 
the foreign exchange rate, or to keep it from declining further, one 
must try to establish a favorable balance of payments. . . . 

The basic fallacy in this theory is that it completely ignores the 
fact that the height of imports and exports depends primarily on 
prices. Neither imports nor exports are undertaken out of 
caprice or just for fun. They are undertaken to carry on a prof- 
itable trade, that is to earn money from the differences in prices 
on either side. Thus imports or exports are carried on until price 
differences disappear. . . . 

The balance of payments doctrine of foreign exchange rates 
completely overlooks the meaning of prices for the international 
movement of goods. It proceeds erroneously from the act of pay- 
ment, instead of from the business transaction itself. That is a 
result of the pseudo-legal monetary theory — a theory which has 
brought the most cruel consequences to German science — the 
theory which looks on money as a means of payment only, and 
not as a general medium of exchange. 

When deciding to undertake a business transaction, a mer- 
chant does not ignore the costs of obtaining the necessary foreign 
currency until the time when the payment actually comes due. A 
merchant who proceeded in this way would not long remain a 
merchant. The merchant takes the ratio of foreign currency very 
much into account in his calculations, as he always has an eye to 
the selling price. Also, whether he hedges against future changes 
in the exchange rate, or whether he bears the risk himself of shifts 
in foreign currency values, he considers the anticipated fluctua- 
tions in foreign exchange. The same situation prevails mutatis 
mutandis with reference to tourist traffic and international 
freight. . . . 

30 For the sake of completeness only, it should be mentioned that the 
adherents of this theory attribute domestic price increases, not to the infla- 
tion, but to the shortage of goods exclusively. 

48 — The Causes of the Economic Crisis 

It is easy to recognize that we find here only a new form of the 
old favorable and unfavorable balance of trade theory champi- 
oned by the Mercantilist School of the sixteenth to eighteenth 
centuries. That was before the widespread use of banknotes and 
other bank currency. The fear was then expressed that a country 
with an unfavorable balance of trade could lose its entire supply 
of the precious metals to other lands. Therefore, it was held that 
by encouraging exports and limiting imports so far as possible, a 
country could take precautions to prevent this from happening. 
Later, the idea developed that the trade balance alone was not 
decisive, that it was only one factor in creating the balance of pay- 
ments and that the entire balance of payments must be 
considered. As a result, the theory underwent a partial reorgani- 
zation. However, its basic tenet — namely that when a government 
did not control its foreign trade relations, all its precious metals 
might flow abroad — persisted until it lost out finally to the hard- 
hitting criticism of Classical economics. 

The balance of payments of a country is nothing but the sum 
of the balances of payments of all its individual enterprises. The 
essence of every balance is that the debit and credit sides are 
equal. If one compares the credit entries and the debit entries of 
an enterprise the two totals must be in balance. The situation can 
be no different in the case of the balance of payments of an entire 
country. Then too, the totals must always be in balance. This 
equilibrium, that must necessarily prevail because goods are 
exchanged — not given away — in economic trading, is not 
brought about by undertaking all exports and imports first, with- 
out considering the means of payment, and then only later 
adjusting the balance in money. Rather, money occupies precisely 
the same position in undertaking a transaction as do the other 
commodities being exchanged. Money may even be the usual 
reason for making exchanges. 

In a society in which commodity transactions are monetary 
transactions, every individual enterprise must always take care to 
have on hand a certain quantity of money. It must not permit its 
cash holding to fall below the definite sum considered necessary 
for carrying out its transactions. On the other hand, an enterprise 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 49 

will not permit its cash holding to exceed the necessary amount, 
for allowing that quantity of money to lie idle will lead to loss of 
interest. If it has too little money, it must reduce purchases or sell 
some wares. If it has too much money, then it must buy goods. 

For our purposes here, it is immaterial whether the enterprise 
buys producers’ or consumers’ goods. In this way, every individ- 
ual sees to it that he is not without money. Because everyone 
pursues his own interest in doing this, it is impossible for the free 
play of market forces to cause a drain of all money out of a city, a 
province or an entire country. The government need not concern 
itself with this problem any more than does the city of Vienna 
with the loss of its monetary stock to the surrounding country- 
side. Nor — assuming a precious metals standard (the purely 
metallic currency of the English Currency School) — need gov- 
ernment concern itself with the possibility that the entire 
country’s stock of precious metals will flow out. 

If we had a pure gold standard, therefore, the government 
need not be in the least concerned about the balance of pay- 
ments. It could safely relinquish to the market the responsibility 
for maintaining a sufficient quantity of gold within the country. 
Under the influence of free trade forces, precious metals would 
leave the country only if a surplus was on hand and they would 
always flow in if too little was available, in the same way that all 
other commodities are imported if in short supply and exported 
if in surplus. Thus, we see that gold is constantly moving from 
large-scale gold producing countries to those in which the 
demand for gold exceeds the quantity mined — without the need 
for any government action to bring this about 31 . . . . 

It may be asked, however, doesn’t history show many examples 
of countries whose metallic money (gold and silver) has flown 
abroad? Didn’t gold coins disappear from the market in Germany 
just recently? Didn’t the silver coins vanish here at home in Austria? 

31 See Hertzka, Das Wesen des Geldes (Leipzig, 1887), pp. 44ff.; Wieser, 
“Der Geldwert und seine Veranderungen” Schriften des Vereins fur 
Sozialpolitik 132 (Leipzig, 1910): 530ff. 

50 — The Causes of the Economic Crisis 

Isn’t this evidence a clear-cut contradiction of the assertion that 
trade spontaneously maintains the monetary stock? Isn’t this proof 
that the state needs to interfere in the balance of payments? 

However, these facts do not in the least contradict our state- 
ment. Money does not flow out because the balance of payments 
is unfavorable and because the state has not interfered. Rather, 
money flows out precisely because the state has intervened and 
the interventions have called forth the phenomenon described by 
the well-known Gresham’s Law. The government itself has 
ruined the currency by the steps it has taken. And then the gov- 
ernment tries in vain, by other measures, to restore the currency 
it has ruined. 

The disappearance of gold money from trade follows from the 
fact that the state equates, in terms of legal purchasing power, a 
lesser-valued money with a higher-valued money. If the govern- 
ment introduces into trade quantities of inconvertible banknotes 
or government notes, then this must lead to a monetary depreci- 
ation. The value of the monetary unit declines. However, this 
depreciation in value can affect only the inconvertible notes. 
Gold money retains all, or almost all, of its value internationally. 
However, since the state — with its power to use the force of law — 
declares the lower-valued monetary notes equal in purchasing 
power to the higher-valued gold money and forbids the gold 
money from being traded at a higher value than the paper notes, 
the gold coins must vanish from the market. They may disappear 
abroad. They may be melted down for use in domestic industry. 
Or they may be hoarded. That is the phenomenon of good money 
being driven out by bad, observed so long ago by Aristophanes, 
which we call Gresham’s Law. 

No special government intervention is needed to retain the 
precious metals in circulation within a country. It is enough for 
the state to renounce all attempts to relieve financial distress by 
resorting to the printing press. To uphold the currency, it need do 
no more than that. And it need do only that to accomplish this 
goal. All orders and prohibitions, all measures to limit foreign 
exchange transactions, etc., are completely useless and purpose- 

Stabilization of the Monetary Unit— From the Viewpoint of Theory — 51 

If we had a pure gold standard, measures to prevent a gold 
outflow from the country due to an unfavorable balance of pay- 
ments would be completely superfluous. He who has no money 
to buy abroad, because he has neither exported goods nor per- 
formed services abroad, will be able to buy abroad only if 
foreigners give him credit. However, his foreign purchases then 
will in no way disturb the stability of the domestic currency. 


Monetary Stabilization and 
Cyclical Policy (1928) 

I n recent years the problems of monetary and banking policy 
have been approached more and more with a view to both 
stabilizing the value of the monetary unit and eliminating 
fluctuations in the economy. Thanks to serious attempts at 
explaining and publicizing these most difficult economic prob- 
lems, they have become familiar to almost everyone. It may 
perhaps be appropriate to speak of fashions in economics, and it 
is undoubtedly the “fashion” today to establish institutions for the 
study of business trends. 

This has certain advantages. Careful attention to these prob- 
lems has eliminated some of the conflicting doctrines which had 
handicapped economics. There is only one theory of monetary 
value today — the Quantity Theory. There is also only one trade 
cycle theory — the Circulation Credit Theory, developed out of 
the Currency Theory and usually called the “Monetary Theory of 
the Trade Cycle.” These theories, of course, are no longer what 
they were in the days of Ricardo and Lord Overstone. They have 
been revised and made consistent with modern subjective eco- 
nomics. Yet the basic principle remains the same. The underlying 
thesis has merely been elaborated upon. So despite all its defects, 
which are now recognized, due credit should be given the 
Currency School for its achievement. 

Geldwertstabilisierung und Konjunkturpolitik (Jena: Gustav Fischer, 1928). 


54 — The Causes of the Economic Crisis 

In this connection, just as in all other aspects of economics, it 
becomes apparent that scientific development goes steadily for- 
ward. Every single step in the development of a doctrine is 
necessary. No intellectual effort applied to these problems is in 
vain. A continuous, unbroken line of scientific progress runs 
from the Classical authors down to the modern writers. The 
accomplishment of Gossen, Menger, Walras, and Jevons, in over- 
coming the apparent antinomy of value during the third quarter 
of the last century, permits us to divide the history of economics 
into two large subdivisions — the Classical, and the Modern or 
Subjective. Still it should be remembered that the contributions 
of the Classical School have not lost all value. They live on in 
modern science and continue to be effective. 

Whenever an economic problem is to be seriously considered, 
it is necessary to expose the violent rejection of economics which 
is carried on everywhere for political reasons, especially on 
German soil. Nothing concerning the problems involved in either 
the creation of the purchasing power of money or economic fluc- 
tuations can be learned from Historicism or Nominalism. 
Adherents of the Historical-Empirical-Realistic School and of 
Institutionalism either say nothing at all about these problems, or 
else they depend on the very same methodological and theoreti- 
cal grounds which they otherwise oppose. The Banking Theory, 
until very recently certainly the leading doctrine, at least in 
Germany, has been justifiably rejected. Hardly anyone who 
wishes to be taken seriously dares to set forth the doctrine of the 
elasticity of the circulation of fiduciary media — its principal the- 
sis and cornerstone . 1 

Sixteen years ago when I presented the circulation credit theory of the 
crisis in the first German edition of my book on The Theory of Money and 
Credit (1912); [English editions, New London, Conn.: Yale University 
Press, 1953; Indianapolis, Ind.: LibertyC/asszcs, 1980], I encountered igno- 
rance and stubborn rejection everywhere, especially in Germany. The 
reviewer for Schmoller’s Yearbook [Jahrbuch fur Gesetzgebung, Verwaltung 
und Volkswirtschaft ] declared: “The conclusions of the entire work [are] 
simply not discussable.” The reviewer for Conrad’s Yearbook \Jahrbuch fur 

Monetary Stabilization and Cyclical Policy — 55 

However, the popularity attained by the two political prob- 
lems of stabilization — the value of the monetary unit and 
fiduciary media — also brings with it serious disadvantages. The 
popularization of a theory always contains a threat of distorting 
it, if not of actually demolishing its very essence. Thus the results 
expected of measures proposed for stabilizing the value of the 
monetary unit and eliminating business fluctuations have been 
very much overrated. This danger, especially in Germany, should 
not be underestimated. During the last ten years, the systematic 
neglect of the problems of economic theory has meant that no 
attention has been paid to accomplishments abroad. Nor has any 
benefit been derived from the experiences of other countries. 

The fact is ignored that proposals for the creation of a mone- 
tary unit with “stable value” have already had a hundred year 
history. Also ignored is the fact that an attempt to eliminate eco- 
nomic crises was made more than eighty years ago — in 
England — through Peel’s Bank Act (1844). It is not necessary to 
put all these proposals into practice to see their inherent difficul- 
ties. However, it is simply inexcusable that so little attention has 
been given during recent generations to the understanding 
gained, or which might have been gained if men had not been so 
blind, concerning monetary policy and fiduciary media. 

Current proposals for a monetary unit of “stable value” and for 
a nonfluctuating economy are, without doubt, more refined than 
were the first attempts of this kind. They take into consideration 
many of the less important objections raised against earlier proj- 
ects. However, the basic shortcomings, which are necessarily 
inherent in all such schemes, cannot be overcome. As a result, 
the high hopes for the proposed reforms must be frustrated. 

Nationalokonomie und Statistik ] stated: “Hypothetically, the author’s argu- 
ments should not be described as completely wrong; they are at least 
coherent.” But his final judgment was “to reject it anyhow.” Anyone who fol- 
lows current developments in economic literature closely, however, knows 
that things have changed basically since then. The doctrine which was 
ridiculed once is widely accepted today. 

56 — The Causes of the Economic Crisis 

If we are to clarify the possible significance — for economic sci- 
ence, public policy and individual action — of the cyclical studies 
and price statistics so widely and avidly pursued today, they must 
be thoroughly and critically analyzed. This can, by no means, be 
limited to considering cyclical changes only. “A theory of crises,” 
as Bohm-Bawerk said, 

can never be an inquiry into just one single phase of eco- 
nomic phenomena. If it is to be more than an amateurish 
absurdity, such an inquiry must be the last, or the next to 
last, chapter of a written or unwritten economic system. 
In other words, it is the final fruit of knowledge of all eco- 
nomic events and their interconnected relationships . 2 

Only on the basis of a comprehensive theory of indirect 
exchange, i.e., a theory of money and banking, can a trade cycle 
theory be erected. This is still frequently ignored. Cyclical theo- 
ries are carelessly drawn up and cyclical policies are even more 
carelessly put into operation. Many a person believes himself 
competent to pass judgment, orally and in writing, on the prob- 
lem of the formulation of monetary value and the rate of interest. 
If given the opportunity — as legislator or manager of a country’s 
monetary and banking policy — he feels called upon to enact rad- 
ical measures without having any clear idea of their 
consequences. Yet, nowhere is more foresight and caution neces- 
sary than precisely in this area of economic knowledge and 
policy. For the superficiality and carelessness, with which social 
problems are wont to be handled, soon misfire if applied in this 
field. Only by serious thought, directed at understanding the 
interrelationship of all market phenomena, can the problems we 
face here be satisfactorily solved. 

2 Zeitschrift fur Volkswirtschaft, Sozialpolitik und. Verwaltung VII, p. 132. 

Monetary Stabilization and Cyclical Policy — 57 

Part A 

Stabilization of the Purchasing 
Power of the Monetary Unit 


The Problem 

1. “Stable Value” Money 

Gold and silver had already served mankind for thousands of 
years as generally accepted media of exchange — that is, as money — 
before there was any clear idea of the formation of the exchange 
relationship between these metals and consumers’ goods, i.e., 
before there was an understanding as to how money prices for 
goods and services are formed. At best, some attention was given to 
fluctuations in the mutual exchange relationships of the two pre- 
cious metals. But so little understanding was achieved that men 
clung, without hesitation, to the naive belief that the precious met- 
als were “stable in value” and hence a useful measure of the value of 
goods and prices. Only much later did the recognition come that 
supply and demand determine the exchange relationship between 
money, on the one hand, and consumers’ goods and services, on the 
other. With this realization, the first versions of the Quantity 
Theory, still somewhat imperfect and vulnerable, were formulated. 
It was known that violent changes in the volume of production of 
the monetary metals led to all-round shifts in money prices. When 
“paper money” was used along side “hard money,” this connection 
was still easier to see. The consequences of a tremendous paper 
inflation could not be mistaken. 

From this insight, the doctrine of monetary policy emerged that 
the issue of “paper money” should be avoided completely. 
However, before long other authors made still further stipulations. 
They called the attention of politicians and businessmen to the 
fluctuations in the purchasing power of the precious metals and 

58 — The Causes of the Economic Crisis 

proposed that the substance of monetary claims be made inde- 
pendent of these variations. Side by side with money as the 
standard of deferred payments, 3 or in place of it, there should be 
a tabular, index, or multiple commodity standard. Cash transac- 
tions, in which the terms of both sides of the contract are fulfilled 
simultaneously, would not be altered. However, a new procedure 
would be introduced for credit transactions. Such transactions 
would not be completed in the sum of money indicated in the 
contract. Instead, either by means of a universally compulsory 
legal regulation or else by specific agreement of the two parties 
concerned, they would be fulfilled by a sum with the purchasing 
power deemed to correspond to that of the original sum at the 
time the contract was made. The intent of this proposal was to 
prevent one party to a contract from being hurt to the other’s 
advantage. These proposals were made more than one hundred 
years ago by Joseph Lowe (1822) and repeated shortly thereafter 
by G. Poulett Scrope (1833). 4 Since then, they have cropped up 
repeatedly but without any attempt having been made to put 
them into practice anywhere. 

2. Recent Proposals 

One of the proposals, for a multiple commodity standard, was 
intended simply to supplement the precious metals standard. 
Putting it into practice would have left metallic money as a univer- 
sally acceptable medium of exchange for all transactions not 
involving deferred monetary payments. (For the sake of simplicity 
in the discussion that follows, when referring to metallic money we 
shall speak only of gold.) Side by side with gold as the universally 

3 [In the German text Mises uses the English term, “Standard of deferred 
payments,” commenting in a footnote: “Standard of deferred payments is 
‘Zahlungsmittel’ in German. Unfortunately this German expression must 
be avoided nowadays. Its meaning has been so compromised through its 
use by Nominalists and Chartists that it brings to mind the recently 
exploded errors of the state theory of money.” See above for comments on 
“state theory of money,” p. 12, n. 9, and “chartism,” p. 20, n. 15.— Ed.] 

4 William Stanley Jevons, Money and the Mechanism of Exchange, 13th 
ed. (London, 1902), pp. 328ff. 

Monetary Stabilization and Cyclical Policy — 59 

acceptable medium of exchange, the index or multiple commodity 
standard would appear as a standard of deferred payments. 

Proposals have been made in recent years, however, which go 
still farther. These would introduce a “tabular,” or “multiple com- 
modity,” standard for all exchanges when one commodity is not 
exchanged directly for another. This is essentially Keynes’s pro- 
posal. Keynes wants to oust gold from its position as money. He 
wants gold to be replaced by a paper standard, at least for trade 
within a country’s borders. The government, or the authority 
entrusted by the government with the management of monetary 
policy, should regulate the quantity in circulation so that the pur- 
chasing power of the monetary unit would remain unchanged . 5 

The American, Irving Fisher, wants to create a standard under 
which the paper dollar in circulation would be redeemable, not in 
a previously specified weight of gold, but in a weight of gold which 
has the same purchasing power the dollar had at the moment of 
the transition to the new currency system. The dollar would then 
cease to represent a fixed amount of gold with changing purchas- 
ing power and would become a changing amount of gold 
supposedly with unchanging purchasing power. It was Fisher’s 
idea that the amount of gold which would correspond to a dollar 
should be determined anew from month to month, according to 
variations detected by the index number . 6 Thus, in the view of 
both these reformers, in place of monetary gold, the value of 
which is independent of the influence of government, a standard 
should be adopted which the government “manipulates” in an 
attempt to hold the purchasing power of the monetary unit stable. 

However, these proposals have not as yet been put into prac- 
tice anywhere, although they have been given a great deal of 
careful consideration. Perhaps no other economic question is 
debated with so much ardor or so much spirit and ingenuity in 
the United States, as that of stabilizing the purchasing power of 

5 John Maynard Keynes, A Tract on Monetary Reform (London, 1923; 
New York, 1924), pp. 177ff. 

6 Irving Fisher, Stabilizing the Dollar (New York, 1925), pp. 79ff. 

60 — The Causes of the Economic Crisis 

the monetary unit. Members of the House of Representatives 
have dealt with the problem in detail. Many scientific works are 
concerned with it. Magazines and daily papers devote lengthy 
essays and articles to it, while important organizations seek to 
influence public opinion in favor of carrying out Fisher’s ideas. 


The Gold Standard 

1. The Demand for Money 

Under the gold standard, the formation of the value of the 
monetary unit is not directly subject to the action of the govern- 
ment. The production of gold is free and responds only to the 
opportunity for profit. All gold not introduced into trade for con- 
sumption or for some other purpose flows into the economy as 
money, either as coins in circulation or as bars or coins in bank 
reserves. Should the increase in the quantity of money exceed the 
increase in the demand for money, then the purchasing power of 
the monetary unit must fall. Likewise, if the increase in the quan- 
tity of money lags behind the increase in the demand for money, 
the purchasing power of the monetary unit will rise. 7 

There is no doubt about the fact that, in the last generation, 
the purchasing power of gold has declined. Yet earlier, during the 
two decades following the German monetary reform and the 
great economic crisis of 1873, there was widespread complaint 
over the decline of commodity prices. Governments consulted 
experts for advice on how to eliminate this generally prevailing 
“evil.” Powerful political parties recommended measures for 
pushing prices up by increasing the quantity of money. In place 

7 [This is not the place to examine further the theory of the formation of 
the purchasing power of the monetary unit. In this connection, see The 
Theory of Money and Credit-, 1953, pp. 97-165; 1980, pp. 117-85.— Ed.] 

Monetary Stabilization and Cyclical Policy — 61 

of the gold standard, they advocated the silver standard, the dou- 
ble standard [bimetallism] or even a paper standard, for they 
considered the annual production of gold too small to meet the 
growing demand for money without increasing the purchasing 
power of the monetary unit. However, these complaints died out 
in the last five years of the nineteenth century, and soon men 
everywhere began to grumble about the opposite situation, i.e., 
the increasing cost of living. Just as they had proposed monetary 
reforms in the 1880s and 1890s to counteract the drop in prices, 
they now suggested measures to stop prices from rising. 

The general advance of the prices of all goods and services in 
terms of gold is due to the state of gold production and the 
demand for gold, both for use as money as well as for other pur- 
poses. There is little to say about the production of gold and its 
influence on the ratio of the value of gold to that of other com- 
modities. It is obvious that a smaller increase in the available 
quantity of gold might have counteracted the depreciation of 
gold. Nor need anything special be said about the industrial uses 
of gold. But the third factor involved, the way demand is created 
for gold as money, is quite another matter. Very careful attention 
should be devoted to this problem, especially as the customary 
analysis ignores most unfairly this monetary demand for gold. 

During the period for which we are considering the develop- 
ment of the purchasing power of gold, various parts of the world, 
which formerly used silver or credit money (“paper money”) 
domestically, have changed over to the gold standard. 
Everywhere, the volume of money transactions has increased 
considerably. The division of labor has made great progress. 
Economic self-sufficiency and barter have declined. Monetary 
exchanges now play a role in phases of economic life where ear- 
lier they were completely unknown. The result has been a 
decided increase in the demand for money. There is no point in 
asking whether this increase in the demand for cash holdings by 
individuals, together with the demand for gold for nonmonetary 
uses, was sufficient to counteract the effect on prices of the new 
gold flowing into the market from production. Statistics on the 
height and fluctuations of cash holdings are not available. Even if 

62 — The Causes of the Economic Crisis 

they could be known, they would tell us little because the changes 
in prices do not correspond with changes in the relationship 
between supply and demand for cash holdings. Of greater impor- 
tance, however, is the observation that the increase in the 
demand for money is not the same thing as an increase in the 
demand for gold for monetary purposes. 

As far as the individual’s cash holding is concerned, claims 
payable in money, which may be redeemed at any time and are 
universally considered safe, perform the service of money. These 
money substitutes — small coins, banknotes and bank deposits 
subject to check or similar payment on demand (checking 
accounts) — may be used just like money itself for the settlement 
of all transactions. Only a part of these money substitutes, how- 
ever, is fully covered by stocks of gold on deposit in the banks’ 
reserves. In the decades of which we speak, the use of money 
substitutes has increased considerably more than has the rise in 
the demand for money and, at the same time, its reserve ratio has 
worsened. As a result, in spite of an appreciable increase in the 
demand for money, the demand for gold has not risen enough for 
the market to absorb the new quantities of gold flowing from 
production without lowering its purchasing power. 

2. Economizing on Money 

If one complains of the decline in the purchasing power of 
gold today, and contemplates the creation of a monetary unit 
whose purchasing power shall be more constant than that of gold 
in recent decades, it should not be forgotten that the principal 
cause of the decline in the value of gold during this period is to 
be found in monetary policy and not in gold production itself. 
Money substitutes not covered by gold, which we call fiduciary 
media, occupy a relatively more important position today in the 
world’s total quantity of money 8 than in earlier years. But this is 
not a development which would have taken place without the 

8 The quantity of “money in the broader sense” is equal to the quantity of 
money proper [i.e., commodity money] plus the quantity of fiduciary media 
[i.e., notes, bank deposits not backed by metal, and subsidiary coins]. 

Monetary Stabilization and Cyclical Policy — 63 

cooperation, or even without the express support, of governmen- 
tal monetary policies. As a matter of fact, it was monetary policy 
itself which was deliberately aimed at a “saving” of gold and, 
which created, thereby, the conditions that led inevitably to the 
depreciation of gold. 

The fact that we use as money a commodity like gold, which 
is produced only with a considerable expenditure of capital and 
labor, saddles mankind with certain costs. If the amount of cap- 
ital and labor spent for the production of monetary gold could 
be released and used in other ways, people could be better sup- 
plied with goods for their immediate needs. There is no doubt 
about that! However, it should be noted that, in return for this 
expenditure, we receive the advantage of having available, for 
settling transactions, a money with a relatively steady value and, 
what is more important, the value of which is not directly influ- 
enced by governments and political parties. However, it is easy 
to understand why men began to ponder the possibility of creat- 
ing a monetary system that would combine all the advantages 
offered by the gold standard with the added virtue of lower 

Adam Smith drew a parallel between the gold and silver which 
circulated in a land as money and a highway on which nothing 
grew, but over which fodder and grain were brought to market. 
The substitution of notes for the precious metals would create, so 
to speak, a “wagon-way through the air,” making it possible to 
convert a large part of the roads into fields and pastures and, 
thus, to increase considerably the yearly output of the economy. 
Then in 1816, Ricardo devised his famous plan for a gold 
exchange standard. According to his proposal, England should 
retain the gold standard, which had proved its value in every 
respect. However, gold coins should be replaced in domestic 
trade by banknotes, and these notes should be redeemable, not in 
gold coins, but in bullion only. Thus the notes would be assured 
of a value equivalent to that of gold and the country would have 
the advantage of possessing a monetary standard with all the 
attributes of the gold standard but at a lower cost. 

64 — The Causes of the Economic Crisis 

Ricardo’s proposals were not put into effect for decades. As a 
matter of fact, they were even forgotten. Nevertheless, the gold 
exchange standard was adopted by a number of countries during 
the 1890s — in the beginning usually as a temporary expedient only, 
without intending to direct monetary policy on to a new course. 
Today it is so widespread that we would be fully justified in 
describing it as “the monetary standard of our age.” 9 However, in a 
majority, or at least in quite a number of these countries, the gold 
exchange standard has undergone a development which entitles it 
to be spoken of rather as a flexible gold exchange standard. 10 
Under Ricardo’s plan, savings would be realized not only by avoid- 
ing the costs of coinage and the loss from wearing coins thin in use, 
but also because the amount of gold required for circulation and 
bank reserves would be less than under the “pure” gold standard. 

Carrying out this plan in a single country must obviously, 
ceteris paribus, reduce the purchasing power of gold. And the 
more widely the system is adopted, the more must the purchas- 
ing power of gold decline. If a single land adopts the gold 
exchange standard, while others maintain a “pure” gold standard, 
then the gold exchange standard country can gain an immediate 
advantage over costs in the other areas. The gold, which is sur- 
plus under the gold exchange standard as compared with the gold 
which would have been called for under the “pure” gold standard, 
may be spent abroad for other commodities. These additional 
commodities represent an improvement in the country’s welfare 
as a result of introducing the gold exchange standard. The gold 
exchange standard renders all the services of the gold standard to 

9 Fritz Machlup, Die Goldkernwahrung (Halberstadt, 1925), p. xi. 

10 [A monetary standard based on a unit with a flexible gold parity; 
Golddevisenkernwahrung, literally a standard based on convertibility into a 
foreign monetary unit, in effect a “flexible gold exchange standard.” In later 
writings, Professor Mises shortened this to “flexible standard” and this 
term will be used henceforth in this translation. See Human Action (1949; 
3rd rev. ed. (New Haven, Conn.: Yale University Press, 1966); Scholar’s 
Edition (Auburn, Ala.: Ludwig von Mises Institute, 1998), chapter XXXI, 
section 3.— Ed.] 

Monetary Stabilization and Cyclical Policy — 65 

this country and also brings an additional advantage in the form 
of this increase of goods. 

However, should every country in the world shift at the same 
time from the “pure” gold standard to a similar gold exchange 
standard, no gain of this kind would be possible. The distribution 
of gold throughout the world would remain unchanged. There 
would be no country where one could exchange a quantity of 
gold, made superfluous by the adoption of the new monetary sys- 
tem, for other goods. Embracing the new standard would result 
only in a universally more severe reduction in the purchasing 
power of gold. This monetary depreciation, like every change in 
the value of money, would bring about dislocations in the rela- 
tionships of wealth and income of the various individuals in the 
economy. As a result, it could also lead indirectly, under certain 
circumstances, to an increase in capital accumulation. However, 
this indirect method will make the world richer only insofar as 
(1) the demand for gold for other uses (industrial and similar pur- 
poses) can be better satisfied and (2) a decline in profitability 
leads to a restriction of gold production and so releases capital 
and labor for other purposes. 

3. Interest on “Idle” Reserves 

In addition to these attempts toward “economy” in the oper- 
ation of the gold standard, by reducing the domestic demand for 
gold, other efforts have also aimed at the same objective. 
Holding gold reserves is costly to the banks of issue because of 
the loss of interest. Consequently, it was but a short step to the 
reduction of these costs by permitting noninterest-bearing gold 
reserves in bank vaults to be replaced by interest-bearing credit 
balances abroad, payable in gold on demand, and by bills of 
exchange payable in gold. Assets of this type enable the banks of 
issue to satisfy demands for gold in foreign trade just as the pos- 
session of a stock of gold coins and bars would. As a matter of 
fact, the dealer in arbitrage who presents notes for redemption 
will prefer payment in the form of checks, and bills of 
exchange — foreign financial paper — to redemption in gold 
because the costs of shipping foreign financial papers are lower 

66 — The Causes of the Economic Crisis 

than those for the transport of gold. The banks of smaller and 
poorer lands especially converted a part of their reserves into 
foreign bills of exchange. The inducement was particularly 
strong in countries on the gold exchange standard, where the 
banks did not have to consider a demand for gold for use in 
domestic circulation. In this way, the gold exchange standard 
[■ Goldkernwahrung ] became the flexible gold exchange standard 
[' Golddevisenkernwahrung ], i.e., the flexible standard. 

Nevertheless, the goal of this policy was not only to reduce the 
costs involved in the maintenance and circulation of an actual 
stock of gold. In many countries, including Germany and Austria, 
this was thought to be a way to reduce the rate of interest. The 
influence of the Currency Theory had led, decades earlier, to 
banking legislation intended to avoid the consequences of a 
paper money inflation. These laws, limiting the issue of bank- 
notes not covered by gold, were still in force. Reared in the 
Historical-Realistic School of economic thinking, the new gener- 
ation, insofar as it dealt with these problems, was under the spell 
of the Banking Theory, and thus no longer understood the mean- 
ing of these laws. 

Lack of originality prevented the new generation from 
embarking upon any startling reversal in policy. In line with cur- 
rently prevailing opinion, it abolished the limitation on the issue 
of banknotes not covered by metal. The old laws were allowed to 
stay on the books essentially unchanged. However, various 
attempts were made to reduce their effect. The most noteworthy 
of these measures was to encourage, systematically and purpose- 
fully, the settlement of transactions without the use of cash. By 
supplanting cash transactions with checks and other transfer 
payments, it was expected not only that there would be a reduc- 
tion in the demand for banknotes but also a flow of gold coins 
back to the bank and, consequently, a strengthening of the bank’s 
cash position. As German, and also Austrian, banking legislation 
prescribed a certain percentage of gold cover for notes issued, 
gold flowing back to the bank meant that more notes could be 
issued— up to three times their gold value in Germany and two 
and a half times in Austria. During recent decades, the banking 

Monetary Stabilization and Cyclical Policy — 67 

theory has been characterized by a belief that this should result 
in a reduction in the rate of interest. 

4. Gold Still Money 

If we glance, even briefly, at the efforts of monetary and bank- 
ing policy in recent years, it becomes obvious that the 
depreciation of gold may be traced in large part to political meas- 
ures. The decline in the purchasing power of gold and the 
continual increase in the gold price of all goods and services were 
not natural phenomena. They were consequences of an eco- 
nomic policy which aimed, to be sure, at other objectives, but 
which necessarily led to these results. As has already been men- 
tioned, accurate quantitative observations about these matters 
can never be made. Nevertheless, it is obvious that the increase 
in gold production has certainly not been the cause, or at least 
not the only cause, of the depreciation of gold that has been 
observed since 1896. The policy directed toward displacing gold 
in actual circulation, which aimed at substituting the gold 
exchange standard and the flexible standard for the older “pure” 
gold standard, forced the value of gold down or at least helped to 
depress it. Perhaps, if this policy had not been followed, we would 
hear complaints today over the increase, rather than the depreci- 
ation, in the value of gold. 

Gold has not been demonetized by the new monetary policy, 
as silver was a short time ago, for it remains the basis of our 
entire monetary system. Gold is still, as it was formerly, our 
money. There is no basis for saying that it has been de-throned, 
as suggested by scatterbrained innovators of catchwords and 
slogans who want to cure the world of the “money illusion.” 
Nevertheless, gold has been removed from actual use in transac- 
tions by the public at large. It has disappeared from view and has 
been concentrated in bank vaults and monetary reserves. Gold 
has been taken out of common use and this must necessarily 
tend to lower its value. 

It is wrong to point to the general price increases of recent 
years to illustrate the inadequacy of the gold standard. It is not 
the old style gold standard, as recommended by advocates of the 

68 — The Causes of the Economic Crisis 

gold standard in England and Germany, which has given us a 
monetary system that has led to rising prices in recent years. 
Rather these price increases have been the results of monetary 
and banking policies which permitted the “pure” or “classical” 
gold standard to be replaced by the gold exchange and flexible 
standards, leaving in circulation only notes and small coins and 
concentrating the gold stocks in bank and currency reserves. 


The “Manipulation of the Gold Standard” 

1. Monetary Policy and Purchasing Power of Gold 

Most important for the old, “pure,” or classical gold standard, 
as originally formulated in England and later, after the formation 
of the Empire, adopted in Germany, was the fact that it made the 
formation of prices independent of political influence and the 
shifting views which sway political action. This feature especially 
recommended the gold standard to liberals 11 who feared that eco- 
nomic productivity might be impaired as a result of the tendency 
of governments to favor certain groups of persons at the expense 
of others. 

1 1 1 employ the term “liberal” in the sense attached to it everywhere 
in the nineteenth century and still today in the countries of conti- 
nental Europe. This usage is imperative because there is simply no 
other term available to signify the political and intellectual move- 
ment that substituted free enterprise and the market economy for 
the precapitalistic methods of production; constitutional repre- 
sentative government from the absolutism of kings or oligarchies; 
and freedom of all individuals from slavery, serfdom, and other 
forms of bondage. (“Foreword to the Third Edition,” Human 
Action [New Haven, Conn.: Yale University Press, 1963], p. v) 

Monetary Stabilization and Cyclical Policy — 69 

However, it should certainly not be forgotten that under the 
“pure” gold standard governmental measures may also have a sig- 
nificant influence on the formation of the value of gold. In the 
first place, governmental actions determine whether to adopt the 
gold standard, abandon it, or return to it. However, the effect of 
these governmental actions, which we need not consider any fur- 
ther here, is conceived as very different from those described by 
the various “state theories of money” — theories which, now at 
long last, are generally recognized as absurd. The continual dis- 
placement of the silver standard by the gold standard and the 
shift in some countries from credit money to gold added to the 
demand for monetary gold in the years before the World War 
[1914-1918]. War measures resulted in monetary policies that 
led the belligerent nations, as well as some neutral states, to 
release large parts of their gold reserves, thus releasing more gold 
for world markets. Every political act in this area, insofar as it 
affects the demand for, and the quantity of, gold as money, repre- 
sents a “manipulation” of the gold standard and affects all 
countries adhering to the gold standard. 

Just as the “pure” gold, the gold exchange and the flexible stan- 
dards do not differ in principle, but only in the degree to which 
money substitutes are actually used in circulation, so is there no 
basic difference in their susceptibility to manipulation. The 
“pure” gold standard is subject to the influence of monetary 
measures — on the one hand, insofar as monetary policy may 
affect the acceptance or rejection of the gold standard in a polit- 
ical area and, on the other hand, insofar as monetary policy, while 
still clinging to the gold standard in principle, may bring about 
changes in the demand for gold through an increase or decrease 
in actual gold circulation or by changes in reserve requirements 
for banknotes and checking accounts. The influence of monetary 
policy on the formation of the value [i.e., the purchasing power] 
of gold also extends just that far and no farther under the gold 
exchange and flexible standards. Here again, governments and 
those agencies responsible for monetary policy can influence the 
formation of the value of gold by changing the course of mone- 
tary policy. The extent of this influence depends on how large the 

70 — The Causes of the Economic Crisis 

increase or decrease in the demand for gold is nationally, in rela- 
tion to the total world demand for gold. 

If advocates of the old “pure” gold standard spoke of the inde- 
pendence of the value of gold from governmental influences, they 
meant that once the gold standard had been adopted everywhere 
(and gold standard advocates of the last three decades of the nine- 
teenth century had not the slightest doubt that this would soon 
come to pass, for the gold standard had already been almost uni- 
versally accepted) no further political action would affect the 
formation of monetary value. This would be equally true for both 
the gold exchange and flexible standards. It would by no means 
disturb the logical assumptions of the perceptive “pure” gold stan- 
dard advocate to say that the value of gold would be considerably 
affected by a change in United States Federal Reserve Board pol- 
icy, such as the resumption of the circulation of gold or the 
retention of larger gold reserves in European countries. In this 
sense, all monetary standards may be “manipulated” under today’s 
economic conditions. The advantage of the gold standard — 
whether “pure” or “gold exchange” — is due solely to the fact that, 
if once generally adopted in a definite form, and adhered to, it is 
no longer subject to specific political interferences. 

War and postwar actions, with respect to monetary policy, 
have radically changed the monetary situation throughout the 
entire world. One by one, individual countries are now [1928] 
reverting to a gold basis and it is likely that this process will 
soon be completed. Now, this leads to a second problem: Should 
the exchange standard, which generally prevails today, be 
retained? Or should a return be made once more to the actual 
use of gold in moderate-sized transactions as before under the 
“pure” gold standard? Also, if it is decided to remain on the 
exchange standard, should reserves actually be maintained in 
gold? And at what height? Or could individual countries be sat- 
isfied with reserves of foreign exchange payable in gold? 
(Obviously, the flexible standard cannot become entirely univer- 
sal. At least one country must continue to invest its reserves in 
real gold, even if it does not use gold in actual circulation.) Only 
if the state of affairs prevailing at a given instant in every single 

Monetary Stabilization and Cyclical Policy — 71 

area is maintained and, also, only if matters are left just as they 
are, including of course the ratio of bank reserves, can it be said 
that the gold standard cannot be manipulated in the manner 
described above. If these problems are dealt with in such a way 
as to change markedly the demand for gold for monetary pur- 
poses, then the purchasing power of gold must undergo 
corresponding changes. 

To repeat for the sake of clarity, this represents no essential 
disagreement with the advocates of the gold standard as to what 
they considered its special superiority. Changes in the monetary 
system of any large and wealthy land will necessarily influence 
substantially the creation of monetary value. Once these changes 
have been carried out and have worked their effect on the pur- 
chasing power of gold, the value of money will necessarily be 
affected again by a return to the previous monetary system. 
However, this detracts in no way from the truth of the statement 
that the creation of value under the gold standard is independent 
of politics, so long as no essential changes are made in its struc- 
ture, nor in the size of the area where it prevails. 

2. Changes in Purchasing Power of Gold 

Irving Fisher, as well as many others, criticize the gold stan- 
dard because the purchasing power of gold has declined 
considerably since 1896, and especially since 1914. In order to 
avoid misunderstanding, it should be pointed out that this drop 
in the purchasing power of gold must be traced back to monetary 
policy — monetary policy which fostered the reduction in the 
purchasing power of gold through measures adopted between 
1896 and 1914, to “economize” gold and, since 1914, through the 
rejection of gold as the basis for money in many countries. If oth- 
ers denounce the gold standard because the imminent return to 
the actual use of gold in circulation and the strengthening of gold 
reserves in countries on the exchange standard would bring 
about an increase in the purchasing power of gold, then it 
becomes obvious that we are dealing with the consequences of 
political changes in monetary policy which transform the struc- 
ture of the gold standard. 

72 — The Causes of the Economic Crisis 

The purchasing power of gold is not “stable.” It should be 
pointed out that there is no such thing as “stable” purchasing 
power, and never can be. The concept of “stable value” is vague 
and indistinct. Strictly speaking, only an economy in the final 
state of rest — where all prices remain unchanged — could have a 
money with fixed purchasing power. However, it is a fact which 
no one can dispute that the gold standard, once generally 
adopted and adhered to without changes, makes the formation of 
the purchasing power of gold independent of the operations of 
shifting political efforts. 

As gold is obtained only from a few sources, which sooner or 
later will be exhausted, the fear is repeatedly expressed that there 
may someday be a scarcity of gold and, as a consequence, a con- 
tinuing decline in commodity prices. Such fears became 
especially great in the late 1870s and the 1880s. Then they qui- 
eted down. Only in recent years have they been revived again. 
Calculations are made indicating that the placers and mines cur- 
rently being worked will be exhausted within the foreseeable 
future. No prospects are seen that any new rich sources of gold 
will be opened up. Should the demand for money increase in the 
future, to the same extent as it has in the recent past, then a gen- 
eral price drop appears inevitable, if we remain on the gold 
standard. 12 

Now one must be very cautious with forecasts of this kind. A 
half century ago, Eduard Suess, the geologist, claimed— and he 
sought to establish this scientifically — that an unavoidable 
decline in gold production should be expected. 13 Facts very soon 
proved him wrong. And it may be that those who express similar 
ideas today will also be refuted just as quickly and just as thor- 
oughly. Still we must agree that they are right in the final analysis, 
that prices are tending to fall [1928] and that all the social conse- 
quences of an increase in purchasing power are making their 

12 Gustav Cassell, Wdhrungsstabilisierung als Weltproblem (Leipzig, 
1928), p. 12. 

13 [Eduard Suess (1831-1914) published a study in German (1877) on 
“The Future of Gold.”— Ed.] 

Monetary Stabilization and Cyclical Policy — 73 

appearance. What may be ventured, given the circumstances, in 
order to change the economic pessimism, will be discussed at the 
end of the second part of this study. 


“Measuring” Changes in the Purchasing 
Power of the Monetary Unit 

1. Imaginary Constructions 

All proposals to replace the commodity money, gold, with a 
money thought to be better, because it is more “stable” in value, 
are based on the vague idea that changes in purchasing power 
can somehow be measured. Only by starting from such an 
assumption is it possible to conceive of a monetary unit with 
unchanging purchasing power as the ideal and to consider seek- 
ing ways to reach this goal. These proposals, vague and basically 
contradictory, are derived from the old, long since exploded, 
objective theory of value. Yet they are not even completely con- 
sistent with that theory. They now appear very much out of place 
in the company of modern, subjective economics. 

The prestige which they still enjoy can be explained only by 
the fact that, until very recently, studies in subjective economics 
have been restricted to the theory of direct exchange (barter). 
Only lately have such studies been expanded to include also the 
theory of intermediate (indirect) exchange, i.e., the theory of a 
generally accepted medium of exchange (monetary theory) and 
the theory of fiduciary media (banking theory) with all their rel- 
evant problems . 14 It is certainly high time to expose conclusively 
the errors and defects of the basic concept that purchasing power 
can be measured. 

u [The Theory of Money and Credit, 1953, pp. 116ff.; 1980, pp. 138ff. — 

74 — The Causes of the Economic Crisis 

Exchange ratios on the market are constantly subject 
to change. If we imagine a market where no generally accepted 
medium of exchange, i.e., no money, is used, it is easy to recog- 
nize how nonsensical the idea is of trying to measure the 
changes taking place in exchange ratios. It is only if we resort to 
the fiction of completely stationary exchange ratios among all 
commodities, other than money, and then compare these other 
commodities with money, that we can envisage exchange rela- 
tionships between money and each of the other individual 
exchange commodities changing uniformly. Only then can we 
speak of a uniform increase or decrease in the monetary price of 
all commodities and of a uniform rise or fall of the “price level.” 
Still, we must not forget that this concept is pure fiction, what 
Vaihinger termed an “as if .” 15 It is a deliberate imaginary con- 
struction, indispensable for scientific thinking. 

Perhaps the necessity for this imaginary construction will 
become somewhat more clear if we express it, not in terms of the 
objective exchange value of the market, but in terms of the sub- 
jective exchange valuation of the acting individual. To do that, we 
must imagine an unchanging man with never- changing values. 
Such an individual could determine, from his never-changing 
scale of values, the purchasing power of money. He could say pre- 
cisely how the quantity of money, which he must spend to attain 
a certain amount of satisfaction, had changed. Nevertheless, the 
idea of a definite structure of prices, a “price level,” which is raised 
or lowered uniformly, is just as fictitious as this. However, it 
enables us to recognize clearly that every change in the exchange 
ratio between a commodity, on the one side, and money, on the 
other, must necessarily lead to shifts in the disposition of wealth 
and income among acting individuals. Thus, each such change 
acts as a dynamic agent also. In view of this situation, therefore, 
it is not permissible to make such an assumption as a uniformly 
changing “level” of prices. 

15 Hans Vaihinger (1852-1933), author of The Philosophy of As If 
(German, 1911; English translation, 1924). 

Monetary Stabilization and Cyclical Policy — 75 

This imaginary construction is necessary, however, to explain 
that the exchange ratios of the various economic goods may 
undergo a change from the side of one individual commodity. 
This fictional concept is the ceteris paribus of the theory of 
exchange relationships. It is just as fictitious and, at the same 
time, just as indispensable as any ceteris paribus. If extraordinary 
circumstances lead to exceptionally large and hence conspicuous 
changes in exchange ratios, data on market phenomena may help 
to facilitate sound thinking on these problems. However, then 
even more than ever, if we want to see the situation at all clearly, 
we must resort to the imaginary construction necessary for an 
understanding of our theory. 

The expressions, “inflation” and “deflation,” scarcely known in 
German economic literature several years ago, are in daily use 
today. In spite of their inexactness, they are undoubtedly suit- 
able for general use in public discussions of economic and 
political problems . 16 But in order to understand them precisely, 
one must elaborate with rigid logic that fictional concept [the 
imaginary construction of completely stationary exchange ratios 
among all commodities other than money], the falsity of which 
is clearly recognized. 

Among the significant services performed by this fiction is 
that it enables us to distinguish and determine whether changes 
in exchange relationships between money and other commodi- 
ties arise on the money side or the commodity side. In order to 
understand the changes which take place constantly on the mar- 
ket, this distinction is urgently needed. It is still more 
indispensable for judging the significance of measures proposed 
or adopted in the field of monetary and banking policy. Even in 
these cases, however, we can never succeed in constructing a fic- 
tional representation that coincides with the situation which 
actually appears on the market. The imaginary construction 

16 [The Theory of Money and Credit, 1953, pp. 239ff; 1980, pp. 271ff.— 

76 — The Causes of the Economic Crisis 

makes it easier to understand reality, but we must remain con- 
scious of the distinction between fiction and reality . 17 

17 [At this point, in a footnote, Professor Mises commented on a contro- 
versy he had had with a student over terminology. He again recommended, 
as he had in 1923 (see above, p. 1, n. 1), continuing to use Menger’s terms 
which enjoyed general acceptance. The simpler English terms, which Mises 
developed and adopted later— notably in Human Action (3rd rev. ed., 1966, 
pp. 419-24; 1998, pp. 416-21), where he describes “goods-induced” or 
“cash-induced” changes in the value of the monetary unit— are used in this 
translation. For those who may be interested in this controversy, the origi- 
nal footnote follows: 

Carl Menger referred to the nature and extent of the influence exerted on 
money/goods exchange ratios [prices] by changes from the money side as 
the problem of the “internal” exchange value ( innere Tauschwert) of money 
[translated in this volume as “cash-induced changes”]. He referred to the 
variations in the purchasing power of the monetary unit due to other 
causes as changes in the “external” exchange value ( aussere Tauschwert ) of 
money [translated as “goods-induced changes”]. I have criticized both 
expressions as being rather unfortunate— because of possible confusion 
with the terms “extrinsic and intrinsic value” as used in Roman canon doc- 
trine, and by English authors of the seventeenth and eighteenth centuries. 
(See the German editions of my book on The Theory of Money and Credit, 
1912, p. 132; 1924, p. 104). Nevertheless, this terminology has attained sci- 
entific acceptance through its use by Menger and it will be used in this 
study when appropriate. 

There is no need to discuss an expression which describes a useful and 
indispensable idea. It is the concept itself, not the term used to describe it, 
which is important. Serious mischief is done if an author chooses a new 
term unnecessarily to express a concept for which a name already exists. 
My student, Gottfried Haberler, has criticized me severely for taking this 
position, reproaching me for being a slave to semantics. (See Haberler, Der 
Sinn der Indexzahlen [Tubingen, 1927], pp. 109ff.). However, in his relevant 
remarks on this problem, Haberler says nothing more than I have. He too 
distinguishes between price changes arising on the goods and money sides. 
Beginners should seek to expand knowledge and avoid spending time on 
useless terminological disputes. As Haberler points out, it would obviously 
be wasted effort to “seek internal and external exchange values of money in 
the real world.” Ideas do not belong to the “real world” at all, but to the 
world of thought and knowledge. 

It is even more astonishing that Haberler finds my critique of attempts to 
measure the value of the monetary unit “inexpedient,” especially as his 
analysis rests entirely on mine. — Ed.] 

Monetary Stabilization and Cyclical Policy — 77 

2. Index Numbers 

Attempts have been made to measure changes in the purchas- 
ing power of money by using data derived from changes in the 
money prices of individual economic goods. These attempts rest 
on the theory that, in a carefully selected index of a large number, 
or of all consumers’ goods, influences from the commodity side 
affecting commodity prices cancel each other out. Thus, so the 
theory goes, the direction and extent of the influence on prices of 
factors arising on the money side may be discovered from such 
an index. Essentially, therefore, by computing an arithmetical 
mean, this method seeks to convert the price changes emerging 
among the various consumers’ goods into a figure which may 
then be considered an index to the change in the value of money. 
In this discussion, we shall disregard the practical difficulties 
which arise in assembling the price quotations necessary to serve 
as the basis for such calculations and restrict ourselves to com- 
menting on the fundamental usefulness of this method for the 
solution of our problem. 

First of all it should be noted that there are various arithmeti- 
cal means. Which one should be selected? That is an old 
question. Reasons may be advanced for, and objections raised 
against, each. From our point of view, the only important thing to 
be learned in such a debate is that the question cannot be settled 
conclusively so that everyone will accept any single answer as 

The other fundamental question concerns the relative 
importance of the various consumer goods. In developing the 
index, if the price of each and every commodity is considered as 
having the same weight, a 50 percent increase in the price of 
bread, for instance, would be offset in calculating the arithmeti- 
cal average by a drop of one-half in the price of diamonds. The 
index would then indicate no change in purchasing power, or 
“price level.” As such a conclusion is obviously preposterous, 
attempts are made in fabricating index numbers, to use the 
prices of various commodities according to their relative impor- 
tance. Prices should be included in the calculations according to 

78 — The Causes of the Economic Crisis 

the coefficient of their importance. The result is then known as 
a “weighted” average. 

This brings us to the second arbitrary decision necessary for 
developing such an index. What is “importance”? Several differ- 
ent approaches have been tried and arguments pro and con each 
have been raised. Obviously, a clear-cut, all-round satisfactory 
solution to the problem cannot be found. Special attention has 
been given the difficulty arising from the fact that, if the usual 
method is followed, the very circumstances involved in deter- 
mining “importance” are constantly in flux; thus the coefficient 
of importance itself is also continuously changing. 

As soon as one starts to take into consideration the “importance” 
of the various goods, one forsakes the assumption of objective 
exchange value — which often leads to nonsensical conclusions as 
pointed out above — and enters the area of subjective values. Since 
there is no generally recognized immutable “importance” to various 
goods, since “subjective” value has meaning only from the point of 
view of the acting individual, further reflection leads eventually to 
the subjective method already discussed — namely the inexcusable 
fiction of a never-changing man with never-changing values. To 
avoid arriving at this conclusion, which is also obviously absurd, 
one remains indecisively on the fence, midway between two equally 
nonsensical methods — on the one side the un-weighted average 
and on the other the fiction of a never-changing individual with 
never-changing values. Yet one believes he has discovered some- 
thing useful. Truth is not the halfway point between two untruths. 
The fact that each of these two methods, if followed to its logical 
conclusion, is shown to be preposterous, in no way proves that a 
combination of the two is the correct one. 

All index computations pass quickly over these unanswerable 
objections. The calculations are made with whatever coefficients 
of importance are selected. However, we have established that 
even the problem of determining “importance” is not capable of 
solution, with certainty, in such a way as to be recognized by 
everyone as “right.” 

Thus the idea that changes in the purchasing power of money 
may be measured is scientifically untenable. This will come as no 

Monetary Stabilization and Cyclical Policy — 79 

surprise to anyone who is acquainted with the fundamental prob- 
lems of modern subjectivistic catallactics and has recognized the 
significance of recent studies with respect to the measurement of 
value 18 and the meaning of monetary calculation . 19 

One can certainly try to devise index numbers. Nowadays 
nothing is more popular among statisticians than this. 
Nevertheless, all these computations rest on a shaky foundation. 
Disregarding entirely the difficulties which, from time to time, 
even thwart agreement as to the commodities whose prices will 
form the basis of these calculations, these computations are arbi- 
trary in two ways — first, with respect to the arithmetical mean 
chosen and, secondly, with respect to the coefficient of impor- 
tance selected. There is no way to characterize one of the many 
possible methods as the only “correct” one and the others as 
“false.” Each is equally legitimate or illegitimate. None is scientif- 
ically meaningful. 

It is small consolation to point out that the results of the vari- 
ous methods do not differ substantially from one another. Even if 
that is the case, it cannot in the least affect the conclusions we 
must draw from the observations we have made. The fact that 
people can conceive of such a scheme at all, that they are not 
more critical, may be explained only by the eventuality of the 
great inflations, especially the greatest and most recent one. 

Any index method is good enough to make a rough statement 
about the extremely severe depreciation of the value of a mone- 
tary unit, such as that wrought in the German inflation. There, 
the index served an instructional task, enlightening a people who 
were inclined to the “State Theory of Money” idea. Nevertheless, 
a method that helps to open the eyes of the people is not neces- 
sarily either scientifically correct or applicable in actual practice. 

18 [See The Theory of Money and Credit, 1953, pp. 38ff.; 1980, pp. 51ff. — 

19 [See Socialism (New Haven, Conn.: Yale University Press, 1951), pp. 
121ff. and (Indianapolis, Ind.: Liberty Fund, 1981), pp. 104.— Ed.] 

80 — The Causes of the Economic Crisis 


Fisher’s Stabilization Plan 

1. Political Problem 

The superiority of the gold standard consists in the fact that 
the value of gold develops independent of political actions. It is 
clear that its value is not “stable.” There is not, and never can be, 
any such thing as stability of value. If, under a “manipulated” 
monetary standard, it was government’s task to influence the 
value of money, the question of how this influence was to be exer- 
cised would soon become the main issue among political and 
economic interests. Government would be asked to influence the 
purchasing power of money so that certain politically powerful 
groups would be favored by its intervention, at the expense of the 
rest of the population. Intense political battles would rage over 
the direction and scope of the edicts affecting monetary policy. 
At times, steps would be taken in one direction, and at other 
times in other directions — in response to the momentary balance 
of political power. The steady, progressive development of the 
economy would continually experience disturbances from the 
side of money. The result of the manipulation would be to pro- 
vide us with a monetary system which would certainly not be any 
more stable than the gold standard. 

If the decision were made to alter the purchasing power of 
money so that the index number always remained unchanged, the 
situation would not be any different. We have seen that there are 
many possible ways, not just one single way, to determine the index 
number. No single one of these methods can be considered the only 
correct one. Moreover, each leads to a different conclusion. Each 
political party would advocate the index method which promised 
results consistent with its political aims at the time. Since it is not 
scientifically possible to find one of the many methods objectively 
right and to reject all others as false, no judge could decide impar- 
tially among groups disputing the correct method of calculation. 

Monetary Stabilization and Cyclical Policy — 81 

In addition, however, there is still one more very important 
consideration. The early proponents of the Quantity Theory 
believed that changes in the purchasing power of the monetary 
unit caused by a change in the quantity of money were exactly 
inversely proportional to one another. According to this Theory, 
a doubling of the quantity of money would cut the monetary 
unit’s purchasing power in half. It is to the credit of the more 
recently developed monetary theory that this version of the 
Quantity Theory has been proved untenable. An increase in the 
quantity of money must, to be sure, lead ceteris paribus to a 
decline in the purchasing power of the monetary unit. Still the 
extent of this decrease in no way corresponds to the extent of the 
increase in the quantity of money. No fixed quantitative relation- 
ship can be established between the changes in the quantity of 
money and those of the unit’s purchasing power . 20 Hence, every 
manipulation of the monetary standard will lead to serious diffi- 
culties. Political controversies would arise not only over the 
“need” for a measure, but also over the degree of inflation or 
restriction, even after agreement had been reached on the pur- 
pose the measure was supposed to serve. 

All this is sufficient to explain why proposals for establishing a 
manipulated standard have not been popular. It also explains — 
even if one disregards the way finance ministers have abused 
their authority — why credit money (commonly known as “paper 
money”) is considered “bad” money. Credit money is considered 
“bad money” precisely because it may be manipulated. 

2. Multiple Commodity Standard 

Proposals that a multiple commodity standard replace, or sup- 
plement, monetary standards based on the precious metals — in 
their role as standards of deferred payments — are by no means 
intended to create a manipulated money. They are not intended 
to change the precious metals standard itself nor its effect on 
value. They seek merely to provide a way to free all transactions 

20 [See The Theory of Money and Credit, 1953, pp. 139ff.; 1980, pp. 
161ff. — Ed.] 

82 — The Causes of the Economic Crisis 

involving future monetary payments from the effect of changes 
in the value of the monetary unit. It is easy to understand why 
these proposals were not put into practice. Relying as they do on 
the shaky foundation of index number calculations, which can- 
not be scientifically established, they would not have produced a 
stable standard of value for deferred payments. They would only 
have created a different standard with different changes in value 
from those under the gold metallic standard. 

To some extent Fisher’s proposals parallel the early ideas of 
advocates of a multiple commodity standard. These forerunners 
also tried to eliminate only the influence of the social effects of 
changes in monetary value on the content of future monetary 
obligations. Like most Anglo-American students of this problem, 
as well as earlier advocates of a multiple commodity standard, 
Fisher took little notice of the fact that changes in the value of 
money have other social effects also. 

Fisher, too, based his proposals entirely on index numbers. 
What seems to recommend his scheme, as compared with pro- 
posals for introducing a “multiple standard,” is the fact that he 
does not use index numbers directly to determine changes in 
purchasing power over a long period of time. Rather he uses 
them primarily to understand changes taking place from month 
to month only. Many objections raised against the use of the 
index method for analyzing longer periods of time will perhaps 
appear less justified when considering only shorter periods. But 
there is no need to discuss this question here, for Fisher did not 
confine the application of his plan to short periods only. Also, 
even if adjustments are always made from month to month only, 
they were to be carried forward, on and on, until eventually cal- 
culations were being made, with the help of the index number, 
which extended over long periods of time. Because of the imper- 
fection of the index number, these calculations would necessarily 
lead in time to errors of very considerable proportions. 

3. Price Premium 

Fisher’s most important contribution to monetary theory is 
the emphasis he gave to the previously little noted effect of 

Monetary Stabilization and Cyclical Policy — 83 

changes in the value of money on the formation of the interest 
rate . 21 Insofar as movements in the purchasing power of money 
can be foreseen, they find expression in the gross interest rate — 
not only as to the direction they will take but also as to their 
approximate magnitude. That portion of the gross interest rate 
which is demanded, and granted, in view of anticipated changes 
in purchasing power is known as the purchasing- power-change 
premium or price-change premium. In place of these clumsy 
expressions we shall use a shorter term — “price premium.” 
Without any further explanation, this terminology leads to an 
understanding of the fact that, given an anticipation of general 
price increases, the price premium is “positive,” thus raising the 
gross rate of interest. On the other hand, with an anticipation of 
general price decreases, the price premium becomes “negative” 
and so reduces the gross interest rate. 

The individual businessman is not generally aware of the fact 
that monetary value is affected by changes from the side of 
money. Even if he were, the difficulties which hamper the forma- 
tion of a halfway reliable judgment, as to the direction and extent 
of anticipated changes, are tremendous, if not outright insur- 
mountable. Consequently, monetary units used in credit 
transactions are generally regarded rather naively as being “sta- 
ble” in value. So, with agreement as to conditions under which 
credit will be applied for and granted, a price premium is not 
generally considered in the calculation. This is practically always 
true, even for long-term credit. If opinion is shaken as to the “sta- 
bility of value” of a certain kind of money, this money is not used 
at all in long-term credit transactions. Thus, in all nations using 
credit money, whose purchasing power fluctuated violently, 
long-term credit obligations were drawn up in gold, whose value 
was held to be “stable.” 

However, because of obstinacy and pro-government bias, 
this course of action was not employed in Germany, nor in 
other countries during the recent inflation. Instead, the idea 

21 Irving Fisher, The Rate of Interest (New York, 1907), pp. 77ff. 

84 — The Causes of the Economic Crisis 

was conceived of making loans in terms of rye and potash. If 
there had been no hope at all of a later compensating revaluation 
of these loans, their price on the exchange in German marks, 
Austrian crowns and similarly inflated currencies would have 
been so high that a positive price premium corresponding to the 
magnitude of the anticipated further depreciation of these cur- 
rencies would have been reflected in the actual interest 

The situation is different with respect to short-term credit 
transactions. Every businessman estimates the price changes 
anticipated in the immediate future and guides himself accord- 
ingly in making sales and purchases. If he expects an increase in 
prices, he will make purchases and postpone sales. To secure the 
means for carrying out this plan, he will be ready to offer higher 
interest than otherwise. If he expects a drop in prices, then he 
will seek to sell and to refrain from purchasing. He will then be 
prepared to lend out, at a cheaper rate, the money made available 
as a result. Thus, the expectation of price increases leads to a pos- 
itive price premium, that of price declines to a negative price 

To the extent that this process correctly anticipates the price 
movements that actually result, with respect to short-term credit, 
it cannot very well be maintained that the content of contractual 
obligations are transformed by the change in the purchasing 
power of money in a way which was neither foreseen nor con- 
templated by the parties concerned. Nor can it be maintained 
that, as a result, shifts take place in the wealth and income rela- 
tionship between creditor and debtor. Consequently, it is 
unnecessary, so far as short-term credit is concerned, to look for 
a more perfect standard of deferred payments. 

Thus we are in a position to see that Fisher’s proposal actu- 
ally offers no more than was offered by any previous plan for a 
multiple standard. In regard to the role of money as a standard 
of deferred payments, the verdict must be that, for long-term 
contracts, Fisher’s scheme is inadequate. For short-term commit- 
ments, it is both inadequate and superfluous. 

Monetary Stabilization and Cyclical Policy — 85 

4. Changes in Wealth and Income 

However, the social consequences of changes in the value of 
money are not limited to altering the content of future monetary 
obligations. In addition to these social effects, which are generally 
the only ones dealt with in Anglo-American literature, there are 
still others. Changes in money prices never reach all commodities 
at the same time, and they do not affect the prices of the various 
goods to the same extent. Shifts in relationships between the 
demand for, and the quantity of, money for cash holdings gener- 
ated by changes in the value of money from the money side do not 
appear simultaneously and uniformly throughout the entire econ- 
omy. They must necessarily appear on the market at some definite 
point, affecting only one group in the economy at first, influencing 
only their judgments of value in the beginning and, as a result, only 
the prices of commodities these particular persons are demanding. 
Only gradually does the change in the purchasing power of the 
monetary unit make its way throughout the entire economy. 

For example, if the quantity of money increases, the additional 
new quantity of money must necessarily flow first of all into the 
hands of certain definite individuals — gold producers, for exam- 
ple, or, in the case of paper money inflation, the coffers of the 
government. It changes only their incomes and fortunes at first 
and, consequently, only their value judgments. Not all goods go 
up in price in the beginning, but only those goods which are 
demanded by these first beneficiaries of the inflation. Only later 
are prices of the remaining goods raised, as the increased quan- 
tity of money progresses step by step throughout the land and 
eventually reaches every participant in the economy . 22 But even 
then, when finally the upheaval of prices due to the new quantity 
of money has ended, the prices of all goods and services will not 
have increased to the same extent. Precisely because the price 
increases have not affected all commodities at one time, shifts in 
the relationships in wealth and income are effected which affect 

22 Hermann Heinrich Gossen, Entwicklung der Gesetze des menschlichen 
Verkehrs und der daraus fliessenden Regeln fur menschliches Handeln (new 
ed.; Berlin, 1889), p. 206. 

86 — The Causes of the Economic Crisis 

the supply and demand of individual goods and services differ- 
ently. Thus, these shifts must lead to a new orientation of the 
market and of market prices. 

Suppose we ignore the consequences of changes in the value 
of money on future monetary obligations. Suppose further that 
changes in the purchasing power of money occur simultaneously 
and uniformly with respect to all commodities in the entire econ- 
omy. Then, it becomes obvious that changes in the value of 
money would produce no changes in the wealth of the individual 
entrepreneurs. Changes in the value of the monetary unit would 
then have no more significance for them than changes in weights 
and measures or in the calendar. 

It is only because changes in the purchasing power of money 
never affect all commodities everywhere simultaneously that 
they bring with them (in addition to their influence on debt 
transactions) still other shifts in wealth and income. The groups 
which produce and sell the commodities that go up in price first 
are benefited by the inflation, for they realize higher profits in the 
beginning and yet they can still buy the commodities they need 
at lower prices, reflecting the previous stock of money. So during 
the inflation of the World War [1914-1918], the producers of war 
materiel and the workers in war industries, who received the out- 
put of the printing presses earlier than other groups of people, 
benefited from the monetary depreciation. At the same time, 
those whose incomes remained nominally the same suffered 
from the inflation, as they were forced to compete in making pur- 
chases with those receiving war inflated incomes. The situation 
became especially clear in the case of government employees. 
There was no mistaking the fact that they were losers. Salary 
increases came to them too late. For some time they had to pay 
prices, already affected by the increase in the quantity of money, 
with money incomes related to previous conditions. 

5. Uncompensatable Changes 

In the case of foreign trade, it was just as easy to see the conse- 
quences of the fact that price changes of the various commodities 
did not take place simultaneously. The deterioration in the value 

Monetary Stabilization and Cyclical Policy —87 

of the monetary unit encourages exports because a part of the 
raw materials, semi-produced factors of production and labor 
needed for the manufacture of export commodities, were pro- 
cured at the old lower prices. At the same time the change in 
purchasing power, which for the time being has affected only a 
part of the domestically-produced commodities, has already had 
an influence on the rate of exchange on the Bourse. The result is 
that the exporter realizes a specific monetary gain. 

The changes in purchasing power arising on the money side 
are considered disturbing not merely because of the transforma- 
tion they bring about in the content of future monetary 
obligations. They are also upsetting because of the uneven timing 
of the price changes of the various goods and services. Can 
Fisher’s dollar of “stable value” eliminate these price changes? 

In order to answer this question, it must be restated that 
Fisher’s proposal does not eliminate changes in the value of the 
monetary unit. It attempts instead to compensate for these 
changes continuously — from month to month. Thus the conse- 
quences associated with the step-by-step emergence of changes 
in purchasing power are not eliminated. Rather they materialize 
during the course of the month. Then, when the correction is 
made at the end of the month, the course of monetary deprecia- 
tion is still not ended. The adjustment calculated at that time is 
based on the index number of the previous month when the full 
extent of that month’s monetary depreciation had not then been 
felt because all prices had not yet been affected. However, the 
prices of goods for which demand was forced up first by the addi- 
tional quantity of money undoubtedly reached heights that may 
not be maintained later. 

Whether or not these two deviations in prices correspond in 
such a way that their effects cancel each other out will depend on 
the specific data in each individual case. Consequently, the mon- 
etary depreciation will continue in the following month, even if 
no further increase in the quantity of money were to appear in 
that month. It would continue to go on until the process finally 
ended with a general increase in commodity prices, in terms of 
gold, and thus with an increase in the value of the gold dollar on 

88 — The Causes of the Economic Crisis 

the basis of the index number. The social consequences of the 
uneven timing of price changes would, therefore, not be avoided 
because the unequal timing of the price changes of various com- 
modities and services would not have been eliminated . 23 

So there is no need to go into more detail with respect to the 
technical difficulties that stand in the way of realizing Fisher’s 
Plan. Even if it could be put into operation successfully, it would 
not provide us with a monetary system that would leave the dis- 
position of wealth and income undisturbed. 


Goods-Induced and Cash-Induced 
Changes in the Purchasing 
Power of the Market 

1. The Inherent Instability of Market Ratios 

Changes in the exchange ratios between money and the vari- 
ous other commodities may originate either from the money side 
or from the commodity side of the transaction. Stabilization pol- 
icy does not aim only at eliminating changes arising on the side 
of money. It also seeks to prevent all future price changes, even if 
this is not always clearly expressed and may sometimes be dis- 

It is not necessary for our purposes to go any further into the 
market phenomena which an increase or decrease in commodities 
must set in motion if the quantity of money remains unchanged . 24 
It is sufficient to point out that, in addition to changes in the 

23 See also my critique of Fisher’s proposal in The Theory of Money and 
Credit, pp. 403ff.; 1980, pp. 442ff. 

24 Whether this is considered a change of purchasing power from the money 
side or from the commodity side is purely a matter of terminology. 

Monetary Stabilization and Cyclical Policy — 89 

exchange ratios among individual commodities, shifts would also 
appear in the exchange ratios between money and the majority of 
the other commodities in the market. A decrease in the quantity of 
other commodities would weaken the purchasing power of the 
monetary unit. An increase would enhance it. ft should be noted, 
however, that the social adjustments which must result from these 
changes in the quantity of other commodities will lead to a reor- 
ganization in the demand for money and hence cash holdings. 
These shifts can occur in such a way as to counteract the imme- 
diate effect of the change in the quantity of goods on the 
purchasing power of the monetary unit. Still for the time being, 
we may ignore this situation. 

The goal of all stabilization proposals, as we have seen, is to 
maintain unchanged the original content of future monetary 
obligations. Creditors and debtors should neither gain nor lose in 
purchasing power. This is assumed to be “just.” Of course, what is 
“just” or “unjust” cannot be scientifically determined. That is a 
question of ultimate purpose and ethical judgment, ft is not a 
question of fact. 

ft is impossible to know just why the advocates of purchasing 
power stabilization see as “just” only the maintenance of an 
unchanged purchasing power for future monetary obligations. 
However, it is easy to understand that they do not want to permit 
either debtor or creditor to gain or lose. They want contractual 
liabilities to continue in force as little altered as possible in the 
midst of the constantly changing world economy. They want to 
transplant contractual liabilities out of the flow of events, so to 
speak, and into a timeless existence. 

Now let us see what this means. Imagine that all production 
has become more fruitful. Goods flow more abundantly than 
ever before. Where only one unit was available for consumption 
before, there are now two. Since the quantity of money has not 
been increased, the purchasing power of the monetary unit has 
risen and with one monetary unit it is possible to buy, let us say, 
one-and-a-half times as much merchandise as before. Whether 
this actually means, if no “stabilization policy” is attempted, that 

90 — The Causes of the Economic Crisis 

the debtor now has a disadvantage and the creditor an advantage 
is not immediately clear. 

If you look at the situation from the viewpoint of the prices of 
the factors of production, it is easy to see why this is the case. For 
the debtor could use the borrowed sum to buy at lower prices fac- 
tors of production whose output has not gone up; or if their 
output has gone up, their prices have not risen correspondingly. 
It might now be possible to buy for less money, factors of produc- 
tion with a productive capacity comparable to that of the factors 
of production one could have bought with the borrowed money 
at the time of the loan. There is no point in exploring the 
uncertainties of theories which do not take into consideration the 
influence that ensuing changes exert on entrepreneurial profit, 
interest and rent. 

However, if we consider changes in real income due to 
increased production, it becomes evident that the situation may 
be viewed very differently from the way it appears to those who 
favor “stabilization.” If the creditor gets back the same nominal 
sum, he can obviously buy more goods. Still, his economic situa- 
tion is not improved as a result. He is not benefited relative to the 
general increase of real income which has taken place. If the mul- 
tiple commodity standard were to reduce in part the nominal 
debt, his economic situation would be worsened. He would be 
deprived of something that, in his view, in all fairness belonged to 
him. Under a multiple commodity standard, interest payable over 
time, life annuities, subsistence allowances, pensions, and the 
like, would be increased or decreased according to the index 
number. Thus, these considerations cannot be summarily dis- 
missed as irrelevant from the viewpoint of consumers. 

We find, on the one hand, that neither the multiple commod- 
ity standard nor Irving Fisher’s specific proposal is capable of 
eliminating the economic concomitants of changes in the value of 
the monetary unit due to the unequal timing in appearance and 
the irregularity in size of price changes. On the other hand, we see 
that these proposals seek to eliminate the repercussions on the 
content of debt agreements, circumstances permitting, in such a 
way as to cause definite shifts in wealth and income relations, 

Monetary Stabilization and Cyclical Policy — 91 

shifts which appear obviously “unjust,” at least to those on whom 
their burden falls. The “justice” of these proposed reforms, there- 
fore, is somewhat more doubtful than their advocates are 
inclined to assume. 

2. The Misplaced Partiality to Debtors 

It is certainly regrettable that this worthy goal cannot be 
attained, at least not by this particular route. These and similar 
efforts are usually acknowledged with sympathy by many who 
recognize their fallacy and their unworkability. This sympathy is 
based ultimately on the intellectual and physical inclination of 
men to be both lazy and resistant to change at the same time. 
Surely everyone wants to see his situation improved with respect 
to his supply of goods and the satisfaction of his wants. Surely 
everyone hopes for changes which would make him richer. Many 
circumstances make it appear that the old and the traditional, 
being familiar, are preferable to the new. Such circumstances 
would include distrust of the individual’s own powers and abili- 
ties, aversion to being forced to adapt in thought and action to 
new situations and, finally, the knowledge that one is no longer 
able, in advanced years of life, to meet his obligations with the 
vitality of youth. 

Certainly, something new is welcomed and gratefully accepted, 
if the something new is beneficial to the individual’s welfare. 
However, any change which brings disadvantages or merely 
appears to bring them, whether or not the change is to blame, is 
considered “unjust.” Those favored by the new state of affairs 
through no special merit on their part quietly accept the increased 
prosperity as a matter of course and even as something already 
long due. Those hurt by the change, however, complain vocifer- 
ously. From such observations, there developed the concepts of a 
“just price” and a “just wage.” Whoever fails to keep up with the 
times and is unable to comply with its demands, becomes a eulo- 
gist of the past and an advocate of the status quo. However, the 
ideal of stability, of the stationary economy, is directly opposed to 
that of continual progress. 

92 — The Causes of the Economic Crisis 

For some time popular opinion has been in sympathy with the 
debtor. The picture of the rich creditor, demanding payment 
from the poor debtor, and the vindictive teachings of moralists 
dominate popular thinking on indebtedness. A byproduct of this 
is to be found in the contrast, made by the contemporaries of the 
Classical School and their followers, between the “idle rich” and 
the “industrious poor.” However, with the development of bonds 
and savings deposits, and with the decline of small-scale enter- 
prise and the rise of big business, a reversal of the former 
situation took place. It then became possible for the masses, with 
their increasing prosperity, to become creditors. The “rich man” 
is no longer the typical creditor, nor the “poor man” the typical 
debtor. In many cases, perhaps even in the majority of cases, the 
relationship is completely reversed. Today, except in the lands of 
farmers and small property owners, the debtor viewpoint is no 
longer that of the masses. Consequently it is also no longer the 
view of the political demagogues. Once upon a time inflation 
may have found its strongest support among the masses, who 
were burdened with debts. But the situation is now very different. 
A policy of monetary restriction would not be unwelcome among 
the masses today, for they would hope to reap a sure gain from it 
as creditors. They would expect the decline in their wages and 
salaries to lag behind, or at any rate not to exceed, the drop in 
commodity prices. 

It is understandable, therefore, that proposals for the creation 
of a “stable value” standard of deferred payments, almost com- 
pletely forgotten in the years when commodity prices were 
declining, have been revived again in the twentieth century. 
Proposals of this kind are always primarily intended for the pre- 
vention of losses to creditors, hardly ever to safeguard 
jeopardized debtor interests. They cropped up in England when 
she was the great world banker. They turned up again in the 
United States at the moment when she started to become a cred- 
itor nation instead of a land of debtors, and they became quite 
popular there when America became the great world creditor. 

Many signs seem to indicate that the period of monetary 
depreciation [due to inflation] is coming to an end. Should this 

Monetary Stabilization and Cyclical Policy — 93 

actually be the case, then the appeal which the idea of a manipu- 
lated standard now enjoys among creditor nations also would 


The Goal of Monetary Policy 


1. Liberalism and the Gold Standard 

Monetary policy of the preliberal era was either crude coin 
debasement, for the benefit of financial administration (only 
rarely intended as Seisachtheia , 26 i.e., to nullify outstanding 
debts), or still more crude paper money inflation. However, in 
addition to, sometimes even instead of, its fiscal goal, the driving 
motive behind paper money inflation very soon became the 
desire to favor the debtor at the expense of the creditor. 

In opposing the depreciated paper standard, liberalism fre- 
quently took the position that after an inflation the value of paper 
money should be raised, through contraction, to its former par- 
ity with metallic money. It was only when men had learned that 
such a policy could not undo or reverse the “unfair” changes in 
wealth and income brought about by the previous inflationary 
period and that an increase in the purchasing power per unit [by 
contraction or deflation] also brings other unwanted shifts of 
wealth and income, that the demand for return to a metallic stan- 
dard at the debased monetary unit’s current parity gradually 
replaced the demand for restoration at the old parity. 

25 I.e., “classical liberalism.” See above, p. 68, note 11. 

26 [In conversation, Professor Mises explained that this is a Greek term, 
meaning “shaking off of burdens.” It was used in the seventh century B.C. 
and later to describe measures enacted to cancel public and private debts, 
completely or in part. Creditors then had to bear the burden, except to the 
extent that they might be indemnified by the government. —Ed.] 

94 — The Causes of the Economic Crisis 

In opposing a single precious metal standard, monetary policy 
exhausted itself in the fruitless attempt to make bimetallism an 
actuality. The results which must follow the establishment of a 
legal exchange ratio between the two precious metals, gold and 
silver, have long been known, even before Classical economics 
developed an understanding of the regularity of market phenom- 
ena. Again and again Gresham’s Law, which applied the general 
theory of price controls to the special case of money, demon- 
strated its validity. Eventually, efforts were abandoned to reach 
the ideal of a bimetallic standard. The next goal then became to 
free international trade, which was growing more and more 
important, from the effects of fluctuations in the ratio between 
the prices of the gold standard and the suppression of the alter- 
nating [bimetallic] and silver standards. Gold then became the 
world’s money. 

With the attainment of gold monometallism, liberals believed 
the goal of monetary policy had been reached. (The fact that 
they considered it necessary to supplement monetary policy 
through banking policy will be examined later in considerable 
detail.) The value of gold was then independent of any direct 
manipulation by governments, political policies, public opinion 
or Parliaments. So long as the gold standard was maintained, 
there was no need to fear severe price disturbances from the side 
of money. The adherents of the gold standard wanted no more 
than this, even though it was not clear to them at first that this 
was all that could be attained. 

2. “Pure” Gold Standard Disregarded 

We have seen how the purchasing power of gold has continu- 
ously declined since the turn of the century. That was not, as 
frequently maintained, simply the consequence of increased gold 
production. There is no way to know whether the increased pro- 
duction of gold would have been sufficient to satisfy the 
increased demand for money without increasing its purchasing 
power, if monetary policy had not intervened as it did. The gold 
exchange and flexible standards were adopted in a number of 
countries, not the “pure” gold standard as its advocates had 

Monetary Stabilization and Cyclical Policy — 95 

expected. “Pure” gold standard countries embraced measures 
which were thought to be, and actually were, steps toward the 
exchange standard. Finally, since 1914, gold has been withdrawn 
from actual circulation almost everywhere. It is primarily due to 
these measures that gold declined in value, thus generating the 
current debate on monetary policy. 

The fault found with the gold standard today is not, therefore, 
due to the gold standard itself. Rather, it is the result of a policy 
which deliberately seeks to undermine the gold standard in order 
to lower the costs of using money and especially to obtain “cheap 
money,” i.e., lower interest rates for loans. Obviously, this policy 
cannot attain the goal it sets for itself. It must eventually bring 
not low interest on loans but rather price increases and distortion 
of economic development. In view of this, then, isn’t it simply 
enough to abandon all attempts to use tricks of banking and 
monetary policy to lower interest rates, to reduce the costs of 
using and circulating money and to satisfy “needs” by promoting 
paper inflation? 

The “pure” gold standard formed the foundation of the mon- 
etary system in the most important countries of Europe and 
America, as well as in Australia. This system remained in force 
until the outbreak of the World War [1914], In the literature on 
the subject, it was also considered the ideal monetary policy 
until very recently. Yet the champions of this “pure” gold stan- 
dard undoubtedly paid too little attention to changes in the 
purchasing power of monetary gold originating on the side of 
money. They scarcely noted the problem of the “stabilization” of 
the purchasing power of money, very likely considering it com- 
pletely impractical. Today we may pride ourselves on having 
grasped the basic questions of price and monetary theory more 
thoroughly and on having discarded many of the concepts which 
dominated works on monetary policy of the recent past. 
However, precisely because we believe we have a better under- 
standing of the problem of value today, we can no longer 
consider acceptable the proposals to construct a monetary sys- 
tem based on index numbers. 

96 — The Causes of the Economic Crisis 

3. The Index Standard 

It is characteristic of current political thinking to welcome every 
suggestion which aims at enlarging the influence of government. If 
the Fisher and Keynes 27 proposals are approved on the grounds 
that they are intended to use government to make the formation of 
monetary value directly subservient to certain economic and polit- 
ical ends, this is understandable. However, anyone who approves of 
the index standard, because he wants to see purchasing power “sta- 
bilized,” will find himself in serious error. 

Abandoning the pursuit of the chimera of a money of 
unchanging purchasing power calls for neither resignation nor 
disregard of the social consequences of changes in monetary 
value. The necessary conclusion from this discussion is that sta- 
bility of the purchasing power of the monetary unit presumes 
stability of all exchange relationships and, therefore, the absolute 
abandonment of the market economy. 

The question has been raised again and again: What will 
happen if, as a result of a technological revolution, gold produc- 
tion should increase to such an extent as to make further 
adherence to the gold standard impossible? A changeover to the 
index standard must follow then, it is asserted, so that it would 
only be expedient to make this change voluntarily now. 
However, it is futile to deal with monetary problems today 
which may or may not arise in the future. We do not know 
under what conditions steps will have to be taken toward solv- 
ing them. It could be that, under certain circumstances, the 
solution may be to adopt a system based on an index number. 
However, this would appear doubtful. Even so, an index stan- 
dard would hardly be a more suitable monetary standard than 
the one we now have. In spite of all its defects, the gold standard 
is a useful and not inexpedient standard. 

27 I<eynes’s 1923 proposal, A Tract on Monetary Reform. 

Monetary Stabilization and Cyclical Policy — 97 

Part B 

Cyclical Policy to 
Eliminate Economic Fluctuations 


Stabilization of the Purchasing 
Power of The Monetary Unit 
and Elimination of the Trade Cycle 

1. Currency School’s Contribution 

S tabilization” of the purchasing power of the monetary unit 
would also lead, at the same time, to the ideal of an econ- 
omy without any changes. In the stationary economy there 
would be no “ups” and “downs” of business. Then, the sequence 
of events would flow smoothly and steadily. Then, no unforeseen 
event would interrupt the provisioning of goods. Then, the act- 
ing individual would experience no disillusionment because 
events did not develop as he had assumed in planning his affairs 
to meet future demands. 

First, we have seen that this ideal cannot be realized. Second, 
we have seen that this ideal is generally proposed as a goal only 
because the problems involved in the formation of purchasing 
power have not been thought through completely. Finally, we have 
seen that even if a stationary economy could actually be realized, 
it would certainly not accomplish what had been expected. Yet 
neither these facts nor the limiting of monetary policy to the 
maintenance of a “pure” gold standard mean that the political slo- 
gan, “Eliminate the business cycle,” is without value. 

It is true that some authors, who dealt with these problems, 
had a rather vague idea that the “stabilization of the price level” 
was the way to attain the goals they set for cyclical policy. Yet 

98 — The Causes of the Economic Crisis 

cyclical policy was not completely spent on fruitless attempts to 
fix the purchasing power of money. Witness the fact that steps 
were undertaken to curb the boom through banking policy, and 
thus to prevent the decline, which inevitably follows the upswing, 
from going as far as it would if matters were allowed to run their 
course. These efforts — undertaken with enthusiasm at a time 
when people did not realize that anything like stabilization of 
monetary value would ever be conceived of and sought after — led 
to measures that had far-reaching consequences. 

We should not forget for a moment the contribution which 
the Currency School made to the clarification of our problem. 
Not only did it contribute theoretically and scientifically but it 
contributed also to practical policy. The recent theoretical treat- 
ment of the problem — in the study of events and statistical data 
and in politics — rests entirely on the accomplishments of the 
Currency School. We have not surpassed Lord Overstone 28 so far 
as to be justified in disparaging his achievement. 

Many modern students of cyclical movements are contemptu- 
ous of theory — not only of this or that theory but of all 
theories — and profess to let the facts speak for themselves. The 
delusion that theory must be distilled from the results of an 
impartial investigation of facts is more popular in cyclical theory 
than in any other field of economics. Yet, nowhere else is it 
clearer that there can be no understanding of the facts without 

Certainly it is no longer necessary to expose once more the 
errors in logic of the Historical-Empirical-Realistic approach to 
the “social sciences .” 29 Only recently has this task been most thor- 
oughly undertaken once more by competent scholars. 
Nevertheless, we continually encounter attempts to deal with the 
business cycle problem while presumably rejecting theory. 

28 [Lord Samuel Jones Loyd Overstone (1796-1883) was an early oppo- 
nent of inconvertible paper money and a leading proponent of the 
principles of the Peel’s Act of 1844.— Ed.] 

29 [See Theory and History (1957; 1969; Auburn, Ala.: Ludwig von Mises 
Institute, 1985).— Ed.] 

Monetary Stabilization and Cyclical Policy — 99 

In taking this approach one falls prey to a delusion which is 
incomprehensible. It is assumed that data on economic fluctua- 
tions are given clearly, directly and in a way that cannot be 
disputed. Thus it remains for science merely to interpret these 
fluctuations — and for the art of politics simply to find ways and 
means to eliminate them. 

2. Early Trade Cycle Theories 

All business establishments do well at times and badly at oth- 
ers. There are times when the entrepreneur sees his profits 
increase daily more than he had anticipated and when, embold- 
ened by these “windfalls,” he proceeds to expand his operations. 
Then, due to an abrupt change in conditions, severe disillusion- 
ment follows this upswing, serious losses materialize, long 
established firms collapse, until widespread pessimism sets in 
which may frequently last for years. Such were the experiences 
which had already been forced on the attention of the business- 
man in capitalistic economies, long before discussions of the 
crisis problem began to appear in the literature. The sudden turn 
from the very sharp rise in prosperity — at least what appeared to 
be prosperity — to a very severe drop in profit opportunities was 
too conspicuous not to attract general attention. Even those who 
wanted to have nothing to do with the business world’s “worship 
of filthy lucre” could not ignore the fact that people who were, or 
had been considered, rich yesterday were suddenly reduced to 
poverty, that factories were shut down, that construction projects 
were left uncompleted, and that workers could not find work. 
Naturally, nothing concerned the businessman more intimately 
than this very problem. 

If an entrepreneur is asked what is going on here — leaving 
aside changes in the prices of individual commodities due to rec- 
ognizable causes — he may very well reply that at times the entire 
“price level” tends upward and then at other times it tends down- 
ward. For inexplicable reasons, he would say, conditions arise 
under which it is impossible to dispose of all commodities, or 
almost all commodities, except at a loss. And what is most curi- 
ous is that these depressing times always come when least 

100 — The Causes of the Economic Crisis 

expected, just when all business had been improving for some 
time so that people finally believed that a new age of steady and 
rapid progress was emerging. 

Eventually, it must have become obvious to the more keenly 
thinking businessman that the genesis of the crisis should be 
sought in the preceding boom. The scientific investigator, whose 
view is naturally focused on the longer period, soon realized that 
economic upswings and downturns alternated with seeming reg- 
ularity. Once this was established, the problem was halfway 
exposed and scientists began to ask questions as to how this 
apparent regularity might be explained and understood. 

Theoretical analysis was able to reject, as completely false, two 
attempts to explain the crisis — the theories of general overpro- 
duction and of underconsumption. These two doctrines have 
disappeared from serious scientific discussion. They persist 
today only outside the realm of science — the theory of general 
overproduction, among the ideas held by the average citizen; and 
the underconsumption theory, in Marxist literature. 

It was not so easy to criticize a third group of attempted expla- 
nations, those which sought to trace economic fluctuations back 
to periodic changes in natural phenomena affecting agricultural 
production. These doctrines cannot be reached by theoretical 
inquiry alone. Conceivably such events may occur and reoccur at 
regular intervals. Whether this actually is the case can be shown 
only by attempts to verify the theory through observation. So far, 
however, none of these “weather theories ” 30 has successfully 
passed this test. 

A whole series of a very different sort of attempts to explain 
the crisis are based on a definite irregularity in the psychological 
and intellectual talents of people. This irregularity is expressed in 
the economy by a change from confidence over the future, which 

30 [Regarding the theories of William Stanley Jevons, Henry L. Moore and 
William Beveridge, see Wesley Clair Mitchell’s Business Cycles (New York: 
National Bureau of Economic Research, 1927), pp. 12ff. — Ed.] 

Monetary Stabilization and Cyclical Policy — 101 

inspires the boom, to despondency, which leads to the crisis and 
to stagnation of business. Or else this irregularity appears as a 
shift from boldly striking out in new directions to quietly follow- 
ing along already well-worn paths. 

What should be pointed out about these doctrines and about 
the many other similar theories based on psychological varia- 
tions is, first of all, that they do not explain. They merely pose the 
problem in a different way. They are not able to trace the change 
in business conditions back to a previously established and iden- 
tified phenomenon. From the periodical fluctuations in 
psychological and intellectual data alone, without any further 
observation concerning the field of labor in the social or other 
sciences, we learn that such economic shifts as these may also be 
conceived of in a different way. So long as the course of such 
changes appears plausible only because of economic fluctuations 
between boom and bust, psychological and other related theories 
of the crisis amount to no more than tracing one unknown factor 
back to something else equally unknown. 

3. The Circulation Credit Theory 

Of all the theories of the trade cycle, only one has achieved 
and retained the rank of a fully-developed economic doctrine. 
That is the theory advanced by the Currency School, the theory 
which traces the cause of changes in business conditions to the 
phenomenon of circulation credit. All other theories of the crisis, 
even when they try to differ in other respects from the line of rea- 
soning adopted by the Currency School, return again and again 
to follow in its footsteps. Thus, our attention is constantly being 
directed to observations which seem to corroborate the 
Currency School’s interpretation. 

In fact, it may be said that the Circulation Credit Theory of the 
Trade Cycle 31 is now accepted by all writers in the field and that 

31 As mentioned above, the most commonly used name for this theory is 
the “monetary theory.” For a number of reasons the designation “circula- 
tion credit theory” is preferable. 

102 — The Causes of the Economic Crisis 

the other theories advanced today aim only at explaining why the 
volume of circulation credit granted by the banks varies from 
time to time. All attempts to study the course of business fluctu- 
ations empirically and statistically, as well as all efforts to 
influence the shape of changes in business conditions by political 
action, are based on the Circulation Credit Theory of the Trade 

To show that an investigation of business cycles is not dealing 
with an imaginary problem, it is necessary to formulate a cycle 
theory that recognizes a cyclical regularity of changes in business 
conditions. If we could not find a satisfactory theory of cyclical 
changes, then the question would remain as to whether or not 
each individual crisis arose from a special cause which we would 
have to track down first. Originally, economics approached the 
problem of the crisis by trying to trace all crises back to specific 
“visible” and “spectacular” causes such as war, cataclysms of 
nature, adjustments to new economic data — for example, changes 
in consumption and technology, or the discovery of easier and 
more favorable methods of production. Crises which could not be 
explained in this way became the specific “problem of the crisis.” 

Neither the fact that unexplained crises still recur again 
and again nor the fact that they are always preceded by a distinct 
boom period is sufficient to prove with certainty that the 
problem to be dealt with is a unique phenomenon originating 
from one specific cause. Recurrences do not appear at regular 
intervals. And it is not hard to believe that the more a crisis con- 
trasts with conditions in the immediately preceding period, the 
more severe it is considered to be. It might be assumed, therefore, 
that there is no specific “problem of the crisis” at all, and that the 
still unexplained crises must be explained by various special 
causes somewhat like the “crisis” which Central European agri- 
culture has faced since the rise of competition from the tilling of 
richer soil in Eastern Europe and overseas, or the “crisis” of the 
European cotton industry at the time of the American Civil War. 
What is true of the crisis can also be applied to the boom. Here 
again, instead of seeking a general boom theory we could look for 
special causes for each individual boom. 

Monetary Stabilization and Cyclical Policy — 103 

Neither the connection between boom and bust nor the cycli- 
cal change of business conditions is a fact that can be established 
independent of theory. Only theory, business cycle theory, per- 
mits us to detect the wavy outline of a cycle in the tangled 
confusion of events . 32 


Circulation Credit Theory 

1. The Banking School Fallacy 

If notes are issued by the banks, or if bank deposits subject to 
check or other claim are opened, in excess of the amount of money 
kept in the vaults as cover, the effect on prices is similar to that 
obtained by an increase in the quantity of money. Since these fiduci- 
ary media, as notes and bank deposits not backed by metal are called, 
render the service of money as safe and generally accepted, payable 
on demand monetary claims, they may be used as money in all trans- 
actions. On that account, they are genuine money substitutes. Since 
they are in excess of the given total quantity of money in the narrower 
sense, they represent an increase in the quantity of money in the 
broader sense. 

The practical significance of these undisputed and indis- 
putable conclusions in the formation of prices is denied by the 
Banking School with its contention that the issue of such fidu- 
ciary media is strictly limited by the demand for money in the 
economy. The Banking School doctrine maintains that if fiduci- 
ary media are issued by the banks only to discount short-term 
commodity bills, then no more would come into circulation 

32 If expressions such as cycle, wave, etc., are used in business cycle the- 
ory, they are merely illustrations to simplify the presentation. One cannot 
and should not expect more from a simile which, as such, must always fall 
short of reality. 

104 — The Causes of the Economic Crisis 

than were “needed” to liquidate the transactions. According to 
this doctrine, bank management could exert no influence on 
the volume of the commodity transactions activated. Purchases 
and sales from which short-term commodity bills originate 
would, by this very transaction, already have brought into exis- 
tence paper credit which can be used, through further 
negotiation, for the exchange of goods and services. If the bank 
discounts the bill and, let us say, issues notes against it, that is, 
according to the Banking School, a neutral transaction as far as 
the market is concerned. Nothing more is involved than replac- 
ing one instrument which is technically less suitable for 
circulation, the bill of exchange, with a more suitable one, the 
note. Thus, according to this School, the effect of the issue of 
notes need not be to increase the quantity of money in circula- 
tion. If the bill of exchange is retired at maturity, then notes 
would flow back to the bank and new notes could enter circula- 
tion again only when new commodity bills came into being 
once more as a result of new business. 

The weak link in this well-known line of reasoning lies in the 
assertion that the volume of transactions completed, as sales 
and purchases from which commodity bills can derive, is inde- 
pendent of the behavior of the banks. If the banks discount at a 
lower, rather than at a higher, interest rate, then more loans are 
made. Enterprises which are unprofitable at 5 percent, and 
hence are not undertaken, may be profitable at 4 percent. 
Therefore, by lowering the interest rate they charge, banks can 
intensify the demand for credit. Then, by satisfying this 
demand, they can increase the quantity of fiduciary media in 
circulation. Once this is recognized, the Banking Theory’s only 
argument, that prices are not influenced by the issue of fiduci- 
ary media, collapses. 

One must be careful not to speak simply of the effects of 
credit in general on prices, but to specify clearly the effects of 
“increased credit” or “credit expansion.” A sharp distinction 
must be made between (1) credit which a bank grants by lend- 
ing its own funds or funds placed at its disposal by depositors, 
which we call “commodity credit,” and (2) that which is granted 

Monetary Stabilization and Cyclical Policy — 1 OS 

by the creation of fiduciary media, i.e., notes and deposits not 
covered by money, which we call “circulation credit .” 33 It is only 
through the granting of circulation credit that the prices of all 
commodities and services are directly affected. 

If the banks grant circulation credit by discounting a three 
month bill of exchange, they exchange a future good — a claim 
payable in three months — for a present good that they produce 
out of nothing. It is not correct, therefore, to maintain that it is 
immaterial whether the bill of exchange is discounted by a bank 
of issue or whether it remains in circulation, passing from hand 
to hand. Whoever takes the bill of exchange in trade can do so 
only if he has the resources. But the bank of issue discounts by 
creating the necessary funds and putting them into circulation. 
To be sure, the fiduciary media flow back again to the bank at 
expiration of the note. If the bank does not give the fiduciary 
media out again, precisely the same consequences appear as 
those which come from a decrease in the quantity of money in 
its broader sense. 

2. Early Effects of Credit Expansion 

The fact that in the regular course of banking operations the 
banks issue fiduciary media only as loans to producers and mer- 
chants means that they are not used directly for purposes of 
consumption . 34 Rather, these fiduciary media are used first of all 
for production, that is to buy factors of production and pay 
wages. The first prices to rise, therefore, as a result of an increase 
of the quantity of money in the broader sense, caused by the issue 
of such fiduciary media, are those of raw materials, semimanu- 
factured products, other goods of higher orders, and wage rates. 

33 [For further explanation of the distinction between “commodity credit” 
and “circulation credit” see Mises’s 1946 essay “The Trade Cycle and Credit 
Expansion: The Economic Consequences of Cheap Money” included later 
in this volume, especially, pp. 193-94.— Ed.] 

34 [In 1928, fiduciary media were issued only by discounting what Mises 
called commodity bills, or short-term (90 days or less) bills of exchange 
endorsed by a buyer and a seller and constituting a lien on the goods sold. 

106 — The Causes of the Economic Crisis 

Only later do the prices of goods of the first order [consumers’ 
goods] follow. Changes in the purchasing power of a monetary 
unit, brought about by the issue of fiduciary media, follow a dif- 
ferent path and have different accompanying social side effects 
from those produced by a new discovery of precious metals or by 
the issue of paper money. Still in the last analysis, the effect on 
prices is similar in both instances. 

Changes in the purchasing power of the monetary unit do not 
directly affect the height of the rate of interest. An indirect influ- 
ence on the height of the interest rate can take place as a result of 
the fact that shifts in wealth and income relationships, appearing 
as a result of the change in the value of the monetary unit, influ- 
ence savings and, thus, the accumulation of capital. If a 
depreciation of the monetary unit favors the wealthier members 
of society at the expense of the poorer, its effect will probably be 
an increase in capital accumulation since the well-to-do are the 
more important savers. The more they put aside, the more their 
incomes and fortunes will grow. 

If monetary depreciation is brought about by an issue of fidu- 
ciary media, and if wage rates do not promptly follow the 
increase in commodity prices, then the decline in purchasing 
power will certainly make this effect much more severe. This is 
the “forced savings” which is quite properly stressed in recent lit- 
erature . 35 However, three things should not be forgotten. First, it 
always depends upon the data of the particular case whether 
shifts of wealth and income, which lead to increased saving, are 

35 Albert Hahn and Joseph Schumpeter have given me credit for the 
expression “forced savings” or “compulsory savings.” See Hahn’s article on 
“Credit” in Handworterbuch der Staatswissenschaften (4th ed., vol. V, p. 
951) and Schumpeter’s The Theory of Economic Development (2nd German 
language ed., 1926 [English translation, Harvard University Press, 1934), p. 
109n.]). To be sure, I described the phenomenon in 1912 in the first 
German language edition of The Theory of Money and Credit [see 1953, pp. 
208ff. and 347ff.; 1980, pp. 238ff. and 385ff. of the English translations]. 
However, I do not believe the expression itself was actually used there. 

Monetary Stabilization and Cyclical Policy — 107 

actually set in motion. Second, under circumstances which need 
not be discussed further here, by falsifying economic calculation, 
based on monetary bookkeeping calculations, a very substantial 
devaluation can lead to capital consumption (such a situation did 
take place temporarily during the recent inflationary period). 
Third, as advocates of inflation through credit expansion should 
observe, any legislative measure which transfers resources to the 
“rich” at the expense of the “poor” will also foster capital forma- 

Eventually, the issue of fiduciary media in such manner can 
also lead to increased capital accumulation within narrow limits 
and, hence, to a further reduction of the interest rate. In the 
beginning, however, an immediate and direct decrease in the 
loan rate appears with the issue of fiduciary media, but this 
immediate decrease in the loan rate is distinct in character and 
degree from the later reduction. The new funds offered on the 
money market by the banks must obviously bring pressure to 
bear on the rate of interest. The supply and demand for loan 
money were adjusted at the interest rate prevailing before the 
issue of any additional supply of fiduciary media. Additional 
loans can be placed only if the interest rate is lowered. Such loans 
are profitable for the banks because the increase in the supply of 
fiduciary media calls for no expenditure except for the mechani- 
cal costs of banking (i.e., printing the notes and bookkeeping). 
The banks can, therefore, undercut the interest rates which 
would otherwise appear on the loan market, in the absence of 
their intervention. Since competition from them compels other 
money lenders to lower their interest charges, the market inter- 
est rate must therefore decline. But can this reduction be 
maintained? That is the problem. 

3. Inevitable Effects of Credit Expansion 
on Interest Rates 

In conformity with Wicksell’s terminology, we shall use “natu- 
ral interest rate” to describe that interest rate which would be 
established by supply and demand if real goods were loaned in 
natura [directly, as in barter] without the intermediary of money. 

108 — The Causes of the Economic Crisis 

“Money rate of interest” will be used for that interest rate asked 
on loans made in money or money substitutes. Through contin- 
ued expansion of fiduciary media, it is possible for the banks to 
force the money rate down to the actual cost of the banking oper- 
ations, practically speaking that is almost to zero. As a result, 
several authors have concluded that interest could be completely 
abolished in this way. Whole schools of reformers have wanted to 
use banking policy to make credit gratuitous and thus to solve the 
“social question.” No reasoning person today, however, believes 
that interest can ever be abolished, nor doubts but what, if the 
“money interest rate” is depressed by the expansion of fiduciary 
media, it must sooner or later revert once again to the “natural 
interest rate.” The question is only how this inevitable adjustment 
takes place. The answer to this will explain at the same time the 
fluctuations of the business cycle. 

The Currency Theory limited the problem too much. It only 
considered the situation that was of practical significance for the 
England of its time — that is, when the issue of fiduciary media is 
increased in one country while remaining unchanged in others. 
Under these assumptions, the situation is quite clear: General 
price increases at home; hence an increase in imports, a drop in 
commodity exports; and with this, as notes can circulate only 
within the country, an outflow of metallic money. To obtain 
metallic money for export, holders of notes present them for 
redemption; the metallic reserves of the banks decline; and con- 
sideration for their own solvency then forces them to restrict the 
credit offered. 

That is the instant at which the business upswing, brought 
about by the availability of easy credit, is demonstrated to be illu- 
sory prosperity. An abrupt reaction sets in. The “money rate of 
interest” shoots up; enterprises from which credit is withdrawn 
collapse and sweep along with them the banks which are their 
creditors. A long persisting period of business stagnation now 
follows. The banks, warned by this experience into observing 
restraint, not only no longer underbid the “natural interest rate” 
but exercise extreme caution in granting credit. 

Monetary Stabilization and Cyclical Policy — 109 

4. The Price Premium 

In order to complete this interpretation, we must, first of all, 
consider the price premium. As the banks start to expand the cir- 
culation credit, the anticipated upward movement of prices 
results in the appearance of a positive price premium. Even if the 
banks do not lower the actual interest rate any more, the gap 
widens between the “money interest rate” and the “natural inter- 
est rate” which would prevail in the absence of their intervention. 
Since loan money is now cheaper to acquire than circumstances 
warrant, entrepreneurial ambitions expand. 

New businesses are started in the expectation that the neces- 
sary capital can be secured by obtaining credit. To be sure, in the 
face of growing demand, the banks now raise the “money interest 
rate.” Still they do not discontinue granting further credit. They 
expand the supply of fiduciary media issued, with the result that 
the purchasing power of the monetary unit must decline still fur- 
ther. Certainly the actual “money interest rate” increases during 
the boom, but it continues to lag behind the rate which would 
conform to the market, i.e., the “natural interest rate” augmented 
by the positive price premium. 

So long as this situation prevails, the upswing continues. 
Inventories of goods are readily sold. Prices and profits rise. 
Business enterprises are overwhelmed with orders because 
everyone anticipates further price increases and workers find 
employment at increasing wage rates. However, this situation 
cannot last forever! 

5. Malinvestment of Available Capital Goods 

The “natural interest rate” is established at that height which 
tends toward equilibrium on the market. The tendency is toward 
a condition where no capital goods are idle, no opportunities for 
starting profitable enterprises remain unexploited and the only 
projects not undertaken are those which no longer yield a profit 
at the prevailing “natural interest rate.” Assume, however, that the 
equilibrium, toward which the market is moving, is disturbed by 
the interference of the banks. Money may be obtained below the 

110 — The Causes of the Economic Crisis 

“natural interest rate.” As a result businesses may be started 
which weren’t profitable before, and which become profitable 
only through the lower than “natural interest rate” which appears 
with the expansion of circulation credit. 

Here again, we see the difference which exists between a drop 
in purchasing power, caused by the expansion of circulation 
credit, and a loss of purchasing power, brought about by an 
increase in the quantity of money. In the latter case [i.e., with an 
increase in the quantity of money in the narrower sense] the 
prices first affected are either (1) those of consumers’ goods only 
or (2) the prices of both consumers’ and producers’ goods. Which 
it will be depends on whether those first receiving the new quan- 
tities of money use this new wealth for consumption or 
production. However, if the decrease in purchasing power is 
caused by an increase in bank created fiduciary media, then it is 
the prices of producers’ goods which are first affected. The prices 
of consumers’ goods follow only to the extent that wages and 
profits rise. 

Since it always requires some time for the market to reach full 
“equilibrium,” the “static” or “natural” 36 prices, wage rates and 
interest rates never actually appear. The process leading to their 
establishment is never completed before changes occur which 
once again indicate a new “equilibrium.” At times, even on the 
unhampered market, there are some unemployed workers, 
unsold consumers’ goods and quantities of unused factors of pro- 
duction, which would not exist under “static equilibrium.” With 
the revival of business and productive activity, these reserves are 
in demand right away. However, once they are gone, the increase 
in the supply of fiduciary media necessarily leads to disturbances 
of a special kind. 

In a given economic situation, the opportunities for produc- 
tion, which may actually be carried out, are limited by the supply 
of capital goods available. Roundabout methods of production 
can be adopted only so far as the means for subsistence exist to 
maintain the workers during the entire period of the expanded 

36 In the language of Knut Wicksell and the classical economists. 

Monetary Stabilization and Cyclical Policy — 111 

process. All those projects, for the completion of which means 
are not available, must be left uncompleted, even though they 
may appear technically feasible — that is, if one disregards the 
supply of capital. However, such businesses, because of the lower 
loan rate offered by the banks, appear for the moment to be prof- 
itable and are, therefore, initiated. However, the existing 
resources are insufficient. Sooner or later this must become evi- 
dent. Then it will become apparent that production has gone 
astray, that plans were drawn up in excess of the economic means 
available, that speculation, i.e., activity aimed at the provision of 
future goods, was misdirected. 

6. “Forced Savings” 

In recent years, considerable significance has been attributed 
to the fact that “forced savings,” which may appear as a result of 
the drop in purchasing power that follows an increase of fiduci- 
ary media, leads to an increase in the supply of capital. The 
subsistence fund is made to go farther, due to the fact that (1) the 
workers consume less because wage rates tend to lag behind the 
rise in the prices of commodities, and (2) those who reap the 
advantage of this reduction in the workers’ incomes save at least 
a part of their gain. Whether “forced savings” actually appear 
depends, as noted above, on the circumstances in each case. 
There is no need to go into this any further. 

Nevertheless, establishing the existence of “forced savings” 
does not mean that bank expansion of circulation credit does not 
lead to the initiation of more roundabout production than avail- 
able capabilities would warrant. To prove that, one must be able 
to show that the banks are only in a position to depress the 
“money interest rate” and expand the issue of fiduciary media to 
the extent that the “natural interest rate” declines as a result of 
“forced savings.” This assumption is simply absurd and there is no 
point in arguing it further. It is almost inconceivable that anyone 
should want to maintain it. 

What concerns us is the problem brought about by the banks, 
in reducing the “money rate of interest” below the “natural rate.” 
For our problem, it is immaterial how much the “natural interest 

112 — The Causes of the Economic Crisis 

rate” may also decline under certain circumstances and within 
narrow limits, as a result of this action by the banks. No one 
doubts that “forced savings” can reduce the “natural interest rate” 
only fractionally, as compared with the reduction in the “money 
interest rate” which produces the “forced savings .” 37 

The resources which are claimed for the newly initiated longer 
time consuming methods of production are unavailable for those 
processes where they would otherwise have been put to use. The 
reduction in the loan rate benefits all producers, so that all pro- 
ducers are now in a position to pay higher wage rates and higher 
prices for the material factors of production. Their competition 
drives up wage rates and the prices of the other factors of produc- 
tion. Still, except for the possibilities already discussed, this does 
not increase the size of the labor force or the supply of available 
goods of the higher order. The means of subsistence are not suf- 
ficient to provide for the workers during the extended period of 
production. It becomes apparent that the proposal for the new, 
longer, roundabout production was not adjusted with a view to 
the actual capital situation. For one thing, the enterprises realize 
that the resources available to them are not sufficient to continue 
their operations. They find that “money” is scarce. 

That is precisely what has happened. The general increase in 
prices means that all businesses need more funds than had been 
anticipated at their “launching.” More resources are required to 
complete them. However, the increased quantity of fiduciary 
media loaned out by the banks is already exhausted. The banks 
can no longer make additional loans at the same interest rates. As 
a result, they must raise the loan rate once more for two reasons. 
In the first place, the appearance of the positive price premium 
forces them to pay higher interest for outside funds which they 

37 I believe this should be pointed out here again, although I have 
exhausted everything to be said on the subject (pp. 105-07) and in The 
Theory of Money and Credit [1953, pp. 361ff.; 1980, pp. 400ff.]. Anyone 
who has followed the discussions of recent years will realize how important 
it is to stress these things again and again. 

Monetary Stabilization and Cyclical Policy — 113 

borrow. Then also, they must discriminate among the many 
applicants for credit. Not all enterprises can afford this increased 
interest rate. Those which cannot run into difficulties. 

7. A Habit-forming Policy 

Now, in extending circulation credit, the banks do not pro- 
ceed by pumping a limited dosage of new fiduciary media into 
circulation and then stop. They expand the fiduciary media con- 
tinuously for some time, sending, so to speak, after the first 
offering, a second, third, fourth, and so on. They do not simply 
undercut the “natural interest rate” once, and then adjust 
promptly to the new situation. Instead they continue the practice 
of making loans below the “natural interest rate” for some time. 
To be sure, the increasing volume of demands on them for credit 
may cause them to raise the “money rate of interest.” Yet, even if 
the banks revert to the former “natural rate,” the rate which pre- 
vailed before their credit expansion affected the market, they still 
lag behind the rate which would now exist on the market if they 
were not continuing to expand credit. This is because a positive 
price premium must now be included in the new “natural rate.” 
With the help of this new quantity of fiduciary media, the banks 
now take care of the businessman's intensified demand for credit. 
Thus, the crisis does not appear yet. The enterprises using more 
roundabout methods of production, which have been started, are 
continued. Because prices rise still further, the earlier calcula- 
tions of the entrepreneurs are realized. They make profits. In 
short, the boom continues. 

8. The Inevitable Crisis and Cycle 

The crisis breaks out only when the banks alter their conduct 
to the extent that they discontinue issuing any more new fiduciary 
media and stop undercutting the “natural interest rate.” They may 
even take steps to restrict circulation credit. When they actually 
do this, and why, is still to be examined. First of all, however, we 
must ask ourselves whether it is possible for the banks to stay on 
the course upon which they have embarked, permitting new 
quantities of fiduciary media to flow into circulation continuously 

114 — The Causes of the Economic Crisis 

and proceeding always to make loans below the rate of interest 
which would prevail on the market in the absence of their inter- 
ference with newly created fiduciary media. 

If the banks could proceed in this manner, with businesses 
improving continually, could they then provide for lasting good 
times? Would they then be able to make the boom eternal? 

They cannot do this. The reason they cannot is that inflation- 
ism carried on ad infinitum is not a workable policy. If the issue 
of fiduciary media is expanded continuously, prices rise ever 
higher and at the same time the positive price premium also rises. 
(We shall disregard the fact that consideration for (1) the contin- 
ually declining monetary reserves relative to fiduciary media and 
(2) the banks’ operating costs must sooner or later compel them 
to discontinue the further expansion of circulation credit.) It is 
precisely because, and only because, no end to the prolonged 
“flood” of expanding fiduciary media is foreseen, that it leads to 
still sharper price increases and, finally, to a panic in which prices 
and the loan rate move erratically upward. 

Suppose the banks still did not want to give up the race? 
Suppose, in order to depress the loan rate, they wanted to satisfy 
the continuously expanding desire for credit by issuing still more 
circulation credit? Then they would only hasten the end, the col- 
lapse of the entire system of fiduciary media. The inflation can 
continue only so long as the conviction persists that it will one 
day cease. Once people are persuaded that the inflation will not 
stop, they turn from the use of this money. They flee then to “real 
values,” foreign money, the precious metals, and barter. 

Sooner or later, the crisis must inevitably break out as the 
result of a change in the conduct of the banks. The later the 
crack-up comes, the longer the period in which the calculation of 
the entrepreneurs is misguided by the issue of additional fiduci- 
ary media. The greater this additional quantity of fiduciary 
money, the more factors of production have been firmly commit- 
ted in the form of investments which appeared profitable only 
because of the artificially reduced interest rate and which prove to 
be unprofitable now that the interest rate has again been raised. 

Monetary Stabilization and Cyclical Policy — 115 

Great losses are sustained as a result of misdirected capital invest- 
ments. Many new structures remain unfinished. Others, already 
completed, close down operations. Still others are carried on 
because, after writing off losses which represent a waste of capital, 
operation of the existing structure pays at least something. 

The crisis, with its unique characteristics, is followed by stag- 
nation. The misguided enterprises and businesses of the boom 
period are already liquidated. Bankruptcy and adjustment have 
cleared up the situation. The banks have become cautious. They 
fight shy of expanding circulation credit. They are not inclined to 
give an ear to credit applications from schemers and promoters. 
Not only is the artificial stimulus to business, through the expan- 
sion of circulation credit, lacking, but even businesses which 
would be feasible, considering the capital goods available, are not 
attempted because the general feeling of discouragement makes 
every innovation appear doubtful. Prevailing “money interest 
rates” fall below the “natural interest rates.” 

When the crisis breaks out, loan rates bound sharply upward 
because threatened enterprises offer extremely high interest rates 
for the funds to acquire the resources, with the help of which they 
hope to save themselves. Later, as the panic subsides, a situation 
develops, as a result of the restriction of circulation credit and 
attempts to dispose of large inventories, causing prices [and the 
“money interest rate”] to fall steadily and leading to the appear- 
ance of a negative price premium. This reduced rate of loan 
interest is adhered to for some time, even after the decline in 
prices comes to a standstill, when a negative price premium no 
longer corresponds to conditions. Thus, it comes about that the 
“money interest rate” is lower than the “natural rate.” Yet, because 
the unfortunate experiences of the recent crisis have made every- 
one uneasy, the incentive to business activity is not as strong as 
circumstances would otherwise warrant. Quite a time passes 
before capital funds, increased once again by savings accumu- 
lated in the meantime, exert sufficient pressure on the loan 
interest rate for an expansion of entrepreneurial activity to 
resume. With this development, the low point is passed and the 
new boom begins. 

116 — The Causes of the Economic Crisis 


The Reappearance of Cycles 

1. Metallic Standard Fluctuations 

From the instant when the banks start expanding the volume 
of circulation credit, until the moment they stop such behavior, 
the course of events is substantially similar to that provoked by 
any increase in the quantity of money. The difference results 
from the fact that fiduciary media generally come into circulation 
through the banks, i.e., as loans, while increases in the quantity of 
money appear as additions to the wealth and income of specific 
individuals. This has already been mentioned and will not be fur- 
ther considered here. Considerably more significant for us is 
another distinction between the two. 

Such increases and decreases in the quantity of money have 
no connection with increases or decreases in the demand for 
money. If the demand for money grows in the wake of a popula- 
tion increase or a progressive reduction of barter and 
self-sufficiency resulting in increased monetary transactions, 
there is absolutely no need to increase the quantity of money. It 
might even decrease. In any event, it would be most extraordi- 
nary if changes in the demand for money were balanced by 
reciprocal changes in its quantity so that both changes were con- 
cealed and no change took place in the monetary unit’s 
purchasing power. 

Changes in the value of the monetary unit are always taking 
place in the economy. Periods of declining purchasing power 
alternate with those of increasing purchasing power. Under a 
metallic standard, these changes are usually so slow and so 
insignificant that their effect is not at all violent. Nevertheless, we 
must recognize that even under a precious metal standard periods 
of ups and downs would still alternate at irregular intervals. In 
addition to the standard metallic money, such a standard would 
recognize only token coins for petty transactions. There would, 

Monetary Stabilization and Cyclical Policy — 117 

of course, be no paper money or any other currency (i.e., either 
notes or bank accounts subject to check which are not fully cov- 
ered). Yet even then, one would be able to speak of economic 
“ups,” “downs” and “waves.” However, one would hardly be 
inclined to refer to such minor alternating “ups” and “downs” as 
regularly recurring cycles. During these periods when purchas- 
ing power moved in one direction, whether up or down, it 
would probably move so slightly that businessmen would 
scarcely notice the changes. Only economic historians would 
become aware of them. Moreover, the fact is that the transition 
from a period of rising prices to one of falling prices would be 
so slight that neither panic nor crisis would appear. This would 
also mean that businessmen and news reports of market activi- 
ties would be less occupied with the “long waves” of the trade 
cycle. 38 

2. Infrequent Recurrences of 
Paper Money Inflations 

The effects of inflations brought about by increases in paper 
money are quite different. They also produce price increases and 
hence “good business conditions,” which are further intensified 
by the apparent encouragement of exports and the hampering of 
imports. Once the inflation comes to an end, whether by a prov- 
idential halt to further increases in the quantity of money (as for 
instance recently in France and Italy) or through complete 
debasement of the paper money due to inflationary policy car- 
ried to its final conclusions (as in Germany in 1923), then the 

38 To avoid misunderstanding, it should be pointed out that the expres- 
sion “long-waves” of the trade cycle is not to be understood here as it was 
used by either Wilhelm Ropke or N.D. Kondratieff. Ropke (Die Konjunktur 
[Jena, 1922], p. 21) considered “long-wave cycles” to be those which lasted 
5-10 years generally. Kondratieff (“Die langen Wellen der Konjunktur” in 
Archiv fur Sozialwissenschaft 56, pp. 573ff.) tried to prove, unsuccessfully 
in my judgment, that, in addition to the 7-11 year cycles of business con- 
ditions which he called medium cycles, there were also regular cyclical 
waves averaging 50 years in length. 

118 — The Causes of the Economic Crisis 

“stabilization crisis ” 39 appears. The cause and appearance of this 
crisis correspond precisely to those of the crisis which comes at 
the close of a period of circulation credit expansion. One must 
clearly distinguish this crisis [i.e., when increases in the quantity 
of money are simply halted] from the consequences which must 
result when the cessation of inflation is followed by deflation. 

There is no regularity as to the recurrence of paper money 
inflations. They generally originate in a certain political attitude, 
not from events within the economy itself. One can only say, with 
certainty, that after a country has pursued an inflationist policy to 
its end or, at least, to substantial lengths, it cannot soon use this 
means again successfully to serve its financial interests. The peo- 
ple, as a result of their experience, will have become distrustful 
and would resist any attempt at a renewal of inflation. 

Even at the very beginning of a new inflation, people would 
reject the notes or accept them only at a far greater discount than 
the actual increased quantity would otherwise warrant. As a rule, 
such an unusually high discount is characteristic of the final 
phases of an inflation. Thus an early attempt to return to a policy 
of paper money inflation must either fail entirely or come very 
quickly to a catastrophic conclusion. One can assume — and mon- 
etary history confirms this, or at least does not contradict 
it — that a new generation must grow up before consideration can 
again be given to bolstering the government’s finances with the 
printing press. 

Many states have never pursued a policy of paper money infla- 
tion. Many have resorted to it only once in their history. Even the 
states traditionally known for their printing press money have 
not repeated the experiment often. Austria waited almost a gen- 
eration after the banknote inflation of the Napoleonic era before 
embarking on an inflation policy again. Even then, the inflation 
was in more modest proportions than at the beginning of the 

39 [The German term, “Sanierungskrise” means literally “restoration cri- 
sis,” i.e., the crisis which comes at the shift to more “healthy” monetary 
relationships. In English this crisis is called the “stabilization crisis.” — Ed.] 

Monetary Stabilization and Cyclical Policy — 119 

nineteenth century. Almost a half century passed between the 
end of her second and the beginning of her third and most recent 
period of inflation. It is by no means possible to speak of cyclical 
reappearances of paper money inflations. 

3. The Cyclical Process oe Credit Expansions 

Regularity can be detected only with respect to the phenom- 
ena originating out of circulation credit. Crises have reappeared 
every few years since banks issuing fiduciary media began to play 
an important role in the economic life of people. Stagnation fol- 
lowed crisis, and following these came the boom again. More 
than ninety years ago Lord Overstone described the sequence in 
a remarkably graphic manner: 

We find it [the “state of trade”] subject to various condi- 
tions which are periodically returning; it revolves 
apparently in an established cycle. First we find it in a 
state of quiescence, — next improvement, — growing 
confidence, — prosperity, — excitement, — overtrading, 

— convulsion, — pressure, — stagnation, — distress, — 
ending again in quiescence . 40 

This description, unrivaled for its brevity and clarity, must be 
kept in mind to realize how wrong it is to give later economists 
credit for transforming the problem of the crisis into the problem 
of general business conditions. 

Attempts have been made, with little success, to supplement 
the observation that business cycles recur by attributing a defi- 
nite time period to the sequence of events. Theories which 
sought the source of economic change in recurring cosmic events 
have, as might be expected, leaned in this direction. A study of 
economic history fails to support such assumptions. It shows 

40 Lord Samuel Jones Loyd Overstone, “Reflections Suggested by a 
Perusal of Mr. J. Horsley Palmer’s Pamphlet on the Causes and 
Consequences of the Pressure on the Money Market,” 1837. (Reprinted in 
Tracts and Other Publications on Metallic and Paper Currency [London, 
1857], p. 31.) 

120 — The Causes of the Economic Crisis 

recurring ups and downs in business conditions, but not ups and 
downs of equal length. 

The problem to be solved is the recurrence of fluctuations in 
business activity. The Circulation Credit Theory shows us, in 
rough outline, the typical course of a cycle. However, so far as we 
have as yet analyzed the theory, it still does not explain why the 
cycle always recurs. 

According to the Circulation Credit Theory, it is clear that the 
direct stimulus which provokes the fluctuations is to be sought in 
the conduct of the banks. Insofar as they start to reduce the 
“money rate of interest” below the “natural rate of interest,” they 
expand circulation credit, and thus divert the course of events 
away from the path of normal development. They bring about 
changes in relationships which must necessarily lead to boom 
and crisis. Thus, the problem consists of asking what leads the 
banks again and again to renew attempts to expand the volume of 
circulation credit. 

Many authors believe that the instigation of the banks’ behav- 
ior comes from outside, that certain events induce them to pump 
more fiduciary media into circulation and that they would 
behave differently if these circumstances failed to appear. I was 
also inclined to this view in the first edition of my book on mon- 
etary theory. 41 1 could not understand why the banks didn’t learn 
from experience. I thought they would certainly persist in a pol- 
icy of caution and restraint, if they were not led by outside 
circumstances to abandon it. Only later did I become convinced 
that it was useless to look to an outside stimulus for the change 
in the conduct of the banks. Only later did I also become con- 
vinced that fluctuations in general business conditions were 

41 See Theorie des Geldes und der Umlaufsmittel (1912), pp. 433ff. I had 
been deeply impressed by the fact that Lord Overstone was also apparently 
inclined to this interpretation. See his “Reflections,” pp. 32ff. [NOTE: 
These paragraphs were deleted from the 2nd German edition (1924) from 
which was made the H.E. Batson English translation, The Theory of Money 
and Credit, published 1934, 1953, and 1971.— Ed.] 

Monetary Stabilization and Cyclical Policy — 121 

completely dependent on the relationship of the quantity of fidu- 
ciary media in circulation to demand. 

Each new issue of fiduciary media has the consequences 
described above. First of all, it depresses the loan rate and then it 
reduces the monetary unit’s purchasing power. Every subsequent 
issue brings the same result. The establishment of new banks of 
issue and their step-by-step expansion of circulation credit pro- 
vides the means for a business boom and, as a result, leads to the 
crisis with its accompanying decline. We can readily understand 
that the banks issuing fiduciary media, in order to improve their 
chances for profit, may be ready to expand the volume of credit 
granted and the number of notes issued. What calls for special 
explanation is why attempts are made again and again to 
improve general economic conditions by the expansion of circu- 
lation credit in spite of the spectacular failure of such efforts in 
the past. 

The answer must run as follows: According to the prevailing 
ideology of businessman and economist-politician, the reduction 
of the interest rate is considered an essential goal of economic 
policy. Moreover, the expansion of circulation credit is assumed 
to be the appropriate means to achieve this goal. 

4. The Mania for Lower Interest Rates 

The naive inflationist theory of the seventeenth and eigh- 
teenth centuries could not stand up in the long run against the 
criticism of economics. In the nineteenth century, that doctrine 
was held only by obscure authors who had no connection with 
scientific inquiry or practical economic policy. For purely politi- 
cal reasons, the school of empirical and historical “Realism” did 
not pay attention to problems of economic theory. It was due 
only to this neglect of theory that the naive theory of inflation 
was once more able to gain prestige temporarily during the 
World War, especially in Germany. 

The doctrine of inflationism by way of fiduciary media was 
more durable. Adam Smith had battered it severely, as had others 

122 — The Causes of the Economic Crisis 

even before him, especially the American William Douglass . 42 
Many, notably in the Currency School, had followed. But then 
came a reversal. The Banking School confused the situation. Its 
founders failed to see the error in their doctrine. They failed to 
see that the expansion of circulation credit lowered the interest 
rate. They even argued that it was impossible to expand credit 
beyond the “needs of business.” So there are seeds in the Banking 
Theory which need only to be developed to reach the conclusion 
that the interest rate can be reduced by the conduct of the banks. 
At the very least, it must be admitted that those who dealt with 
those problems did not sufficiently understand the reasons for 
opposing credit expansion to be able to overcome the public 
clamor for the banks to provide “cheap money.” 

In discussions of the rate of interest, the economic press 
adopted the questionable jargon of the business world, speaking 
of a “scarcity” or an “abundance” of money and calling the short 
term loan market the “money market.” Banks issuing fiduciary 
media, warned by experience to be cautious, practiced discre- 
tion and hesitated to indulge the universal desire of the press, 
political parties, parliaments, governments, entrepreneurs, 
landowners and workers for cheaper credit. Their reluctance to 
expand credit was falsely attributed to reprehensible motives. 
Even newspapers, that knew better, and politicians, who should 
have known better, never tired of asserting that the banks of 
issue could certainly discount larger sums more cheaply if they 
were not trying to hold the interest rate as high as possible out of 
concern for their own profitability and the interests of their con- 
trolling capitalists. 

Almost without exception, the great European banks of issue 
on the continent were established with the expectation that the 
loan rate could be reduced by issuing fiduciary media. Under the 
influence of the Currency School doctrine, at first in England and 

42 William Douglass (1691-1752), a renowned physician, came to 
America in 1716. His “A Discourse Concerning the Currencies of the 
British Plantations in America” (1739) first appeared anonymously. 

Monetary Stabilization and Cyclical Policy — 123 

then in other countries where old laws did not restrict the issue 
of notes, arrangements were made to limit the expansion of cir- 
culation credit, at least of that part granted through the issue of 
uncovered banknotes. Still, the Currency Theory lost out as a 
result of criticism by Tooke (1774-1858) and his followers. 
Although it was considered risky to abolish the laws which 
restricted the issue of notes, no harm was seen in circumventing 
them. Actually, the letter of the banking laws provided for a con- 
centration of the nation’s supply of precious metals in the vaults 
of banks of issue. This permitted an increase in the issue of fidu- 
ciary media and played an important role in the expansion of the 
gold exchange standard. 

Before the war [1914], there was no hesitation in Germany in 
openly advocating withdrawal of gold from trade so that the 
Reichsbank might issue sixty marks in notes for every twenty 
marks in gold added to its stock. Propaganda was also made for 
expanding the use of payments by check with the explanation 
that this was a means to lower the interest rate substantially. 43 
The situation was similar elsewhere, although perhaps more cau- 
tiously expressed. 

Every single fluctuation in general business conditions — the 
upswing to the peak of the wave and the decline into the trough 
which follows — is prompted by the attempt of the banks of issue 
to reduce the loan rate and thus expand the volume of circulation 
credit through an increase in the supply of fiduciary media (i.e., 
banknotes and checking accounts not fully backed by money). 
The fact that these efforts are resumed again and again in spite of 
their widely deplored consequences, causing one business cycle 
after another, can be attributed to the predominance of an ideol- 
ogy — an ideology which regards rising commodity prices and 
especially a low rate of interest as goals of economic policy. The 
theory is that even this second goal may be attained by the expan- 
sion of fiduciary media. Both crisis and depression are lamented. 
Yet, because the causal connection between the behavior of the 

43 [See the examples cited in The Theory of Money and Credit (pp. 387ff.; 1980, 
pp. 426ff.). — Ed.] 

124 — The Causes of the Economic Crisis 

banks of issue and the evils complained about is not correctly 
interpreted, a policy with respect to interest is advocated which, in 
the last analysis, must necessarily always lead to crisis and depres- 

5. Free Banking 

Every deviation from the prices, wage rates and interest rates 
which would prevail on the unhampered market must lead to dis- 
turbances of the economic “equilibrium.” This disturbance, 
brought about by attempts to depress the interest rate artificially, 
is precisely the cause of the crisis. 

The ultimate cause, therefore, of the phenomenon of wave 
after wave of economic ups and downs is ideological in character. 
The cycles will not disappear so long as people believe that the 
rate of interest may be reduced, not through the accumulation of 
capital, but by banking policy. 

Even if governments had never concerned themselves with the 
issue of fiduciary media, there would still be banks of issue and 
fiduciary media in the form of notes as well as checking accounts. 
There would then be no legal limitation on the issue of fiduciary 
media. Free banking would prevail. However, banks would have 
to be especially cautious because of the sensitivity to loss of rep- 
utation of their fiduciary media, which no one would be forced to 
accept. In the course of time, the inhabitants of capitalistic coun- 
tries would learn to differentiate between good and bad banks. 
Those living in “undeveloped” countries would distrust all banks. 
No government would exert pressure on the banks to discount 
on easier terms than the banks themselves could justify. 
However, the managers of solvent and highly respected banks, 
the only banks whose fiduciary media would enjoy the general 
confidence essential for money-substitute quality, would have 
learned from past experiences. Even if they scarcely detected the 
deeper correlations, they would nevertheless know how far they 
might go without precipitating the danger of a breakdown. 

The cautious policy of restraint on the part of respected and 
well-established banks would compel the more irresponsible 

Monetary Stabilization and Cyclical Policy — 125 

managers of other banks to follow suit, however much they 
might want to discount more generously. For the expansion of 
circulation credit can never be the act of one individual bank 
alone, nor even of a group of individual banks. It always requires 
that the fiduciary media be generally accepted as a money substi- 
tute. If several banks of issue, each enjoying equal rights, existed 
side by side, and if some of them sought to expand the volume of 
circulation credit while the others did not alter their conduct, 
then at every bank clearing, demand balances would regularly 
appear in favor of the conservative enterprises. As a result of the 
presentation of notes for redemption and withdrawal of their 
cash balances, the expanding banks would very quickly be com- 
pelled once more to limit the scale of their emissions. 

In the course of the development of a banking system with fidu- 
ciary media, crises could not have been avoided. However, as soon 
as bankers recognized the dangers of expanding circulation credit, 
they would have done their utmost, in their own interests, to avoid 
the crisis. They would then have taken the only course leading to 
this goal: extreme restraint in the issue of fiduciary media. 

6. Government Intervention in Banking 

The fact that the development of fiduciary media banking 
took a different turn may be attributed entirely to the circum- 
stance that the issue of banknotes (which for a long time were the 
only form of fiduciary media and are today [1928] still the more 
important, even in the United States and England) became a pub- 
lic concern. The private bankers and joint-stock banks were 
supplanted by the politically privileged banks of issue because 
the governments favored the expansion of circulation credit for 
reasons of fiscal and credit policy. The privileged institutions 
could proceed unhesitatingly in the granting of credit, not only 
because they usually held a monopoly in the issue of notes, but 
also because they could rely on the government’s help in an 
emergency. The private banker would go bankrupt, if he ven- 
tured too far in the issue of credit. The privileged bank received 
permission to suspend payments and its notes were made legal 
tender at face value. 

126 — The Causes of the Economic Crisis 

If the knowledge derived from the Currency Theory had led to 
the conclusion that fiduciary media should be deprived of all spe- 
cial privileges and placed, like other claims, under general law in 
every respect and without exception, this would probably have 
contributed more toward eliminating the threat of crises than 
was actually accomplished by establishing rigid proportions for 
the issue of fiduciary media in the form of notes and restricting 
the freedom of banks to issue fiduciary media in the form of 
checking accounts. The principle of free banking was limited to 
the field of checking accounts. In fact, it could not function here 
to bring about restraint on the part of banks and bankers. Public 
opinion decreed that government should be guided by a different 
policy — a policy of coming to the assistance of the central banks 
of issue in times of crises. To permit the Bank of England to lend 
a helping hand to banks which had gotten into trouble by 
expanding circulation credit, the Peel Act was suspended in 1847, 
1857 and 1866. Such assistance, in one form or another, has been 
offered time and again everywhere. 

In the United States, national banking legislation made it tech- 
nically difficult, if not entirely impossible, to grant such aid. The 
system was considered especially unsatisfactory, precisely 
because of the legal obstacles it placed in the path of helping 
grantors of credit who became insolvent and of supporting the 
value of circulation credit they had granted. Among the reasons 
leading to the significant revision of the American banking system 
[i.e., the Federal Reserve Act of 1913], the most important was the 
belief that provisions must be made for times of crises. In other 
words, just as the emergency institution of Clearing House 
Certificates was able to save expanding banks, so should technical 
expedients be used to prevent the breakdown of the banks and 
bankers whose conduct had led to the crisis. It was usually consid- 
ered especially important to shield the banks which expanded 
circulation credit from the consequences of their conduct. One of 
the chief tasks of the central banks of issue was to jump into this 
breach. It was also considered the duty of those other banks who, 
thanks to foresight, had succeeded in preserving their solvency, 
even in the general crisis, to help fellow banks in difficulty. 

Monetary Stabilization and Cyclical Policy — 127 

7. Intervention No Remedy 

It may well be asked whether the damage inflicted by misguid- 
ing entrepreneurial activity by artificially lowering the loan rate 
would be greater if the crisis were permitted to run its course. 
Certainly many saved by the intervention would be sacrificed in 
the panic, but if such enterprises were permitted to fail, others 
would prosper. Still the total loss brought about by the “boom” 
(which the crisis did not produce, but only made evident) is 
largely due to the fact that factors of production were expended 
for fixed investments which, in the light of economic conditions, 
were not the most urgent. As a result, these factors of production 
are now lacking for more urgent uses. If intervention prevents 
the transfer of goods from the hands of imprudent entrepreneurs 
to those who would now take over because they have evidenced 
better foresight, this imbalance becomes neither less significant 
nor less perceptible. 

In any event, the practice of intervening for the benefit of 
banks, rendered insolvent by the crisis, and of the customers of 
these banks, has resulted in suspending the market forces which 
could serve to prevent a return of the expansion, in the form of a 
new boom, and the crisis which inevitably follows. If the banks 
emerge from the crisis unscathed, or only slightly weakened, 
what remains to restrain them from embarking once more on an 
attempt to reduce artificially the interest rate on loans and 
expand circulation credit? If the crisis were ruthlessly permitted 
to run its course, bringing about the destruction of enterprises 
which were unable to meet their obligations, then all entrepre- 
neurs — not only banks but also other businessmen — would 
exhibit more caution in granting and using credit in the future. 
Instead, public opinion approves of giving assistance in the crisis. 
Then, no sooner is the worst over, than the banks are spurred on 
to a new expansion of circulation credit. 

To the businessman, it appears most natural and understand- 
able that the banks should satisfy his demand for credit by the 
creation of fiduciary media. The banks, he believes, should have 
the task and the duty to “stand by” business and trade. There is 

128 — The Causes of the Economic Crisis 

no dispute but that the expansion of circulation credit furthers 
the accumulation of capital within the narrow limits of the 
“forced savings” it brings about and to that extent permits an 
increase in productivity. Still it can be argued that, given the sit- 
uation, each step in this direction steers business activity, in the 
manner described above, on a “wrong” course. The discrepancy 
between what the entrepreneurs do and what the unhampered 
market would have prescribed becomes evident in the crisis. The 
fact that each crisis, with its unpleasant consequences, is fol- 
lowed once more by a new “boom,” which must eventually 
expend itself as another crisis, is due only to the circumstances 
that the ideology which dominates all influential groups — politi- 
cal economists, politicians, statesmen, the press and the business 
world — not only sanctions, but also demands, the expansion of 
circulation credit. 


The Crisis Policy of the Currency School 

1. The Inadequacy of the Currency School 

Every advance toward explaining the problem of business fluc- 
tuations to date is due to the Currency School. We are also 
indebted to this School alone for the ideas responsible for policies 
aimed at eliminating business fluctuations. The fatal error of the 
Currency School consisted in the fact that it failed to recognize 
the similarity between banknotes and bank demand deposits as 
money substitutes and, thus, as money certificates and fiduciary 
media. In their eyes, only the banknote was a money substitute. 
In their view, therefore, the circulation of pure metallic money 
could only be adulterated by the introduction of a banknote not 
covered by money. 

Monetary Stabilization and Cyclical Policy — 129 

Consequently, they thought that the only thing that needed to 
be done to prevent the periodic return of crises was to set a rigid 
limit for the issue of banknotes not backed by metal. The issue of 
fiduciary media in the form of demand deposits not covered by 
metal was left free . 44 Since nothing stood in the way of granting 
circulation credit through bank deposits, the policy of expanding 
circulation credit could be continued even in England. When 
technical difficulties limited further bank loans and precipitated a 
crisis, it became customary to come to the assistance of the banks 
and their customers with special issues of notes. The practice of 
restricting the notes in circulation not covered by metal, by limit- 
ing the ratio of such notes to metal, systematized this procedure. 
Banks could expand the volume of credit with ease if they could 
count on the support of the bank of issue in an emergency. 

If all further expansion of fiduciary media had been forbidden 
in any form, that is, if the banks had been obliged to hold full 
reserves for both the additional notes issued and increases in cus- 
tomers’ demand deposits subject to check or similar claim — or at 
least had not been permitted to increase the quantity of fiduciary 
media beyond a strictly limited ratio — prices would have 
declined sharply, especially at times when the increased demand 
for money surpassed the increase in its quantity. The economy 
would then not only have lacked the drive contributed by any 
“forced savings,” it would also have temporarily suffered from the 
consequences of a rise in the monetary unit’s purchasing power 
[i.e., falling prices]. Capital accumulation would then have been 
slowed down, although certainly not stopped. In any case, the 
economy surely would not then have experienced periods of 
stormy upswings followed by dramatic reversals of the upswings 
into crises and declines. 

There is little sense in discussing whether it would have been 
better to restrict, in this way, the issue of fiduciary media by the 

44 Even the countries that have followed different procedures in this 
respect have, for all practical purposes, placed no obstacle in the way of the 
development of fiduciary media in the form of bank deposits. 

130 — The Causes of the Economic Crisis 

banks than it was to pursue the policy actually followed. The 
alternatives are not merely restriction or freedom in the issue of 
fiduciary media. The alternatives are, or at least were, privilege in 
the granting of fiduciary media or true free banking. 

The possibility of free banking has scarcely even been sug- 
gested. Intervention cast its first shadow over the capitalistic 
system when banking policy came to the forefront of economic 
and political discussion. To be sure, some authors, who defended 
free banking, appeared on the scene. However, their voices were 
overpowered. The desired goal was to protect the noteholders 
against the banks. It was forgotten that those hurt by the danger- 
ous suspension of payments by the banks of issue are always the 
very ones the law was intended to help. No matter how severe the 
consequences one may anticipate from a breakdown of the banks 
under a system of absolutely free banking, one would have to 
admit that they could never even remotely approach the severity 
of those brought about by the war and postwar banking policies 
of the three European empires . 45 

2. “Booms” Favored 

In the last two generations, hardly anyone, who has given this 
matter some thought, can fail to know that a crisis follows a 
boom. Nevertheless, it would have been impossible for even the 
sharpest and cleverest banker to suppress in time the expansion 
of circulation credit. Public opinion stood in the way. The fact 
that business conditions fluctuated violently was generally 
assumed to be inherent in the capitalistic system. Under the 
influence of the Banking Theory, it was thought that the banks 
merely went along with the upswing and that their conduct had 
nothing to do with bringing it about or advancing it. If, after a 

45 [According to Professor Mises, the “three European empires” were 
Austria-Hungary, Germany and Russia. This designation probably comes 
from the “Three Emperors’ League” (1872), an informal alliance among 
these governments. Its effectiveness was declining by 1890, and World War 
I dealt it a final blow.— Ed.] 

Monetary Stabilization and Cyclical Policy — 131 

long period of stagnation, the banks again began to respond to 
the general demand for easier credit, public opinion was always 
delighted by the signs of the start of a boom. 

In view of the prevailing ideology, it would have been com- 
pletely unthinkable for the banks to apply the brakes at the start 
of such a boom. If business conditions continued to improve, 
then, in conformity with the principles of Lord Overstone, 
prophecies of a reaction certainly increased in number. However, 
even those who gave this warning usually did not call for a rigor- 
ous halt to all further expansion of circulation credit. They asked 
only for moderation and for restricting newly granted credits to 
“non-speculative” businesses. 

Then finally, if the banks changed their policy and the crisis 
came, it was always easy to find culprits. But there was no desire 
to locate the real offender — the false theoretical doctrine. So no 
changes were made in traditional procedures. Economic waves 
continued to follow one another. 

The managers of the banks of issue have carried out their pol- 
icy without reflecting very much on its basis. If the expansion of 
circulation credit began to alarm them, they proceeded, not 
always very skillfully, to raise the discount rate. Thus, they 
exposed themselves to public censure for having initiated the cri- 
sis by their behavior. It is clear that the crisis must come sooner 
or later. It is also clear that the crisis must always be caused, pri- 
marily and directly, by the change in the conduct of the banks. If 
we speak of error on the part of the banks, however, we must 
point to the wrong they do in encouraging the upswing. The fault 
lies, not with the policy of raising the interest rate, but only with 
the fact that it was raised too late. 

132 — The Causes of the Economic Crisis 


Modern Cyclical Policy 

1. Pre-World War I Policy 

The cyclical policy recommended today, in most of the litera- 
ture dealing with the problem of business fluctuations and 
toward which considerable strides have already been made in the 
United States, rests entirely on the reasoning of the Circulation 
Credit Theory . 46 The aim of much of this literature is to make 
this theory useful in practice by studying business conditions 
with precise statistical methods. 

There is no need to explain further that there is only one busi- 
ness cycle theory — the Circulation Credit Theory. All other 
attempts to cope with the problem have failed to withstand criti- 
cism. Every crisis policy and every cyclical policy has been 
derived from this theory. Its ideas have formed the basis of those 
cyclical and crisis policies pursued in the decades preceding the 
war. Thus, the Banking Theory, then recognized in literature as 
the only correct explanation, as well as all those interpretations 
which related the problem to the theory of direct exchange, were 
already disregarded. It may have still been popular to speak of the 
elasticity of notes in circulation as depending on the discounting 
of commodity bills of exchange. However, in the world of the 
bank managers, who made cyclical policy, other views prevailed. 

To this extent, therefore, one cannot say that the theory 
behind today’s cyclical policy is new. The Circulation Credit 
Theory has, to be sure, come a long way from the old Currency 
Theory. The studies which Walras, Wicksell and I have devoted 

46 [Mises undoubtedly refers here to the way the Lederal Reserve System 
reacted to the post World War I boom, when it brought an end to credit 
expansion by raising the discount rate, thus precipitating the 1920-1921 
correction period, popularly called a “recession.”— Ed.] 

Monetary Stabilization and Cyclical Policy — 133 

to the problem have conceived of it as a more general phenome- 
non. These studies have related it to the whole economic process. 
They have sought to deal with it especially as a problem of inter- 
est rate formulation and of “equilibrium” on the loan market. To 
recognize the extent of the progress made, compare, for instance, 
the famous controversy over free credit between Bastiat and 
Proudhon . 47 Or compare the usual criticism of the Quantity 
Theory in prewar German literature with recent discussions on 
the subject. However, no matter how significant this progress 
may be considered for the development of our understanding, we 
should not forget that the Currency Theory had already offered 
policy making every assistance in this regard that a theory can. 

It is certainly not to be disputed that substantial progress was 
made when the problem was considered, not only from the point 
of view of fiduciary media, but from that of the entire problem of 
the purchasing power of money. The Currency School paid 
attention to price changes only insofar as they were produced by 
an increase or decrease of circulation credit— but they consid- 
ered only the circulation credit granted by the issue of notes. 
Thus, the Currency School was a long way from striving for sta- 
bilization of the purchasing power of the monetary unit. 

2. Post-World War I Policies 

Today these two problems, the issuance of fiduciary media 
and the purchasing power of the monetary unit, are seen as being 
closely linked to the Circulation Credit Theory. One of the ten- 
dencies of modern cyclical policy is that these two problems are 
treated as one. Thus, one aim of cyclical policy is no more nor 

47 [Frederic Bastiat (1801-1850) replied to an open letter addressed to 
him by an editor of Voix du Peuple (October 22, 1849). Then the Socialist, 
Pierre Jean Proudhon (1809-1865), answered. Proudhon, an advocate of 
unlimited monetary expansion by reduction of the interest rate to zero, and 
Bastiat, who favored moderate credit expansion and only a limited reduc- 
tion of interest rates, carried on a lengthy exchange for several months, 
until March 7, 1850. ( Oeuvres Completes de Frederic Bastiat, 4th ed., vol. 5 
[Paris, 1878], pp. 93-336.) —Ed.] 

134 — The Causes of the Economic Crisis 

less than the stabilization of the purchasing power of money. For 
a discussion of this see Part I of this study. 

Like the Currency School, the other aim is not to stabilize pur- 
chasing power but only to avoid the crisis. However, a still further 
goal is contemplated — similar to that sought by the Peel Act and 
by prewar cyclical policy. It is proposed to counteract a boom, 
whether caused by an expansion of fiduciary media or by a mon- 
etary inflation (for example, an increase in the production of 
gold). Then, again, depression is to be avoided when there is 
restriction irrespective of whether it starts with a contraction in 
the quantity of money or of fiduciary media. The aim is not to 
keep prices stable, but to prevent the free market interest rate 
from being reduced temporarily by the banks of issue or by mon- 
etary inflation. 

In order to explain the essence of this new policy, we shall now 
explore two specific cases in more detail: 

1. The production of gold increases and prices rise. A price 
premium appears in the interest rate that would limit the demand 
for loans to the supply of lendable funds available. The banks, 
however, have no reason to raise their lending rate. As a matter of 
fact, they become more willing to discount at a lower rate as the 
relationship between their obligations and their stock of gold has 
been improved. It has certainly not deteriorated. The actual loan 
rate they are asking lags behind the interest rate that would pre- 
vail on a free market, thus providing the initiative for a boom. In 
this instance, prewar crisis policy would not have intervened since 
it considered only the ratio of the bank’s cover which had not 
deteriorated. As prices and wages rise [resulting in an increased 
demand for business loans], modern theory maintains that the 
interest rates should rise and circulation credit be restricted. 

2. The inducement to the boom has been given by the banks 
in response, let us say, to the general pressure to make credit 
cheaper in order to combat depression, without any change in the 
quantity of money in the narrower sense. Since the cover ratio 
deteriorates as a result, even the older crisis policy would have 
called for increasing the interest rate as a brake. 

Monetary Stabilization and Cyclical Policy — 135 

Only in the first of these two instances does a fundamental dif- 
ference exist between old and new policies. 

3. Empirical Studies 

Many now engaged in cyclical research maintain that the spe- 
cial superiority of current crisis policy in America rests on the 
use of more precise statistical methods than those previously 
available. Presumably, means for eliminating seasonal fluctua- 
tions and the secular general trend have been developed from 
statistical series and curves. Obviously, it is only with such 
manipulations that the findings of a market study may become a 
study of the business cycle. However, even if one should agree 
with the American investigators in their evaluation of the success 
of this effort, the question remains as to the usefulness of index 
numbers. Nothing more can be added to what has been said 
above on the subject, in Part I of this study. 

The development of the Three Market Barometer 48 is consid- 
ered the most important accomplishment of the Harvard 
investigations. Since it is not possible to determine Wicksell’s 
natural rate of interest or the “ideal” price premium, we are 
advised to compare the change in the interest rate with the move- 
ment of prices and other data indicative of business conditions, 
such as production figures, the number of unemployed, etc. This 
has been done for decades. One need only glance at reports in the 
daily papers, economic weeklies, monthlies and annuals of the 
last two generations to discover that the many claims, made so 
proudly today, of being the first to recognize the significance of 
such data for understanding the course of business conditions, 
are unwarranted. The Harvard institute, however, has performed 
a service in that it has sought to establish an empirical regularity 
in the timing of the movements in the three curves. 

48 This Harvard barometer was developed at the University by the 
Committee on Economic Research from three statistical series which are 
presumed to reveal (1) the extent of stock speculation, (2) the condition of 
industry and trade and (3) the supply of funds. 

136 — The Causes of the Economic Crisis 

There is no need to share the exuberant expectations for the 
practical usefulness of the Harvard barometer which has pre- 
vailed in the American business world for some time. It can 
readily be admitted that this barometer has scarcely contributed 
anything toward increasing and deepening our knowledge of 
cyclical movements. Nevertheless, the significance of the 
Harvard barometer for the investigation of business conditions 
may still be highly valued, for it does provide statistical substan- 
tiation of the Circulation Credit Theory. Twenty years ago, it 
would not have been thought possible to arrange and manipulate 
statistical material so as to make it useful for the study of business 
conditions. Here real success has crowned the ingenious work 
done by economists and statisticians together. 

Upon examining the curves developed by institutes using the 
Harvard method, it becomes apparent that the movement of the 
money market curve (C Curve) in relation to the stock market 
curve (A Curve) and the commodity market curve (B Curve) cor- 
responds exactly to what the Circulation Credit Theory asserts. 
The fact that the movements of A Curve generally anticipate those 
of B Curve is explained by the greater sensitivity of stock, as 
opposed to commodity, speculation. The stock market reacts more 
promptly than does the commodity market. It sees more and it 
sees farther. It is quicker to draw coming events (in this case, the 
changes in the interest rate) into the sphere of its conjectures. 

4. Arbitrary Political Decisions 

However, the crucial question still remains: What does the 
Three Market Barometer offer the man who is actually making 
bank policy? Are modern methods of studying business condi- 
tions better suited than the former, to be sure less thorough, ones 
for laying the groundwork for decisions on a discount policy 
aimed at reducing as much as possible the ups and downs of busi- 
ness? Even prewar [World War I] banking policy had this for its 
goal. There is no doubt but that government agencies responsible 
for financial policy, directors of the central banks of issue and 
also of the large private banks and banking houses, were frankly 

Monetary Stabilization and Cyclical Policy — 137 

and sincerely interested in attaining this goal. Their efforts in this 
direction — only when the boom was already in full swing to be 
sure — were supported at least by a segment of public opinion and 
of the press. They knew well enough what was needed to accom- 
plish the desired effect. They knew that nothing but a timely and 
sufficiently far-reaching increase in the loan rate could counter- 
act what was usually referred to as “excessive speculation.” 

They failed to recognize the fundamental problem. They did 
not understand that every increase in the amount of circulation 
credit (whether brought about by the issue of banknotes or 
expanding bank deposits) causes a surge in business and thus 
starts the cycle which leads once more, over and beyond the cri- 
sis, to the decline in business activity. In short, they embraced the 
very ideology responsible for generating business fluctuations. 
However, this fact did not prevent them, once the cyclical 
upswing became obvious, from thinking about its unavoidable 
outcome. They did not know that the upswing had been gener- 
ated by the conduct of the banks. If they had, they might well have 
seen it only as a blessing of banking policy, for to them the most 
important task of economic policy was to overcome the depres- 
sion, at least so long as the depression lasted. Still they knew that 
a progressing upswing must lead to crisis and then to stagnation. 

As a result, the trade boom evoked misgivings at once. The 
immediate problem became simply how to counteract the 
onward course of the “unhealthy” development. There was no 
question of “whether,” but only of “how.” Since the method — 
increasing the interest rate — was already settled, the question of 
“how” was only a matter of timing and degree: When and how 
much should the interest rate be raised? 

The critical point was that this question could not be answered 
precisely, on the basis of undisputed data. As a result, the decision 
must always be left to discretionary judgment. Now, the more 
firmly convinced those responsible were that their interference, by 
raising the interest rate, would put an end to the prosperity of the 
boom, the more cautiously they must act. Might not those voices 
be correct which maintained that the upswing was not “artificially” 
produced, that there wasn’t any “overspeculation” at all, that the 

138 — The Causes of the Economic Crisis 

boom was only the natural outgrowth of technical progress, the 
development of means of communication, the discovery of new 
supplies of raw materials, the opening up of new markets? Should 
this delightful and happy state of affairs be rudely interrupted? 
Should the government act in such a way that the economic 
improvement, for which it took credit, gives way to crisis? 

The hesitation of officials to intervene is sufficient to explain 
the situation. To be sure, they had the best of intentions for stop- 
ping in time. Even so, the steps they took were usually “too little 
and too late.” There was always a time lag before the interest rate 
reached the point at which prices must start down again. In the 
interim, capital had become frozen in investments for which it 
would not have been used if the interest rate on money had not 
been held below its “natural rate.” 

This drawback to cyclical policy is not changed in any respect 
if it is carried out in accordance with the business barometer. No 
one who has carefully studied the conclusions, drawn from obser- 
vations of business conditions made by institutions working with 
modern methods, will dare to contend that these results may be 
used to establish, incontrovertibly, when and how much to raise 
the interest rate in order to end the boom in time before it has led 
to capital malinvestment. The accomplishment of economic jour- 
nalism in reporting regularly on business conditions during the 
last two generations should not be underrated. Nor should the 
contribution of contemporary business cycle research institutes, 
working with substantial means, be overrated. Despite all the 
improvements which the preparation of statistics and graphic 
interpretations have undergone, their use in the determination of 
interest rate policy still leaves a wide margin for judgment. 

5. Sound Theory Essential 

Moreover, it should not be forgotten that it is impossible to 
answer in a straightforward manner not only how seasonal vari- 
ations and growth factors are to be eliminated, but also how to 
decide unequivocably from what data and by what method the 
curves of each of the Three Markets should be constructed. 

Monetary Stabilization and Cyclical Policy — 139 

Arguments which cannot be easily refuted may be raised on 
every point with respect to the business barometer. Also, no mat- 
ter how much the business barometer may help us to survey the 
many heterogeneous operations of the market and of production, 
they certainly do not offer a solid basis for weighing contingen- 
cies. Business barometers are not even in a position to furnish 
clear and certain answers to the questions concerning cyclical 
policy which are crucial for their operation. Thus, the great 
expectations generally associated with recent cyclical policy 
today are not justified. 

For the future of cyclical policy more profound theoretical 
knowledge concerning the nature of changes in business condi- 
tions would inevitably be of incomparably greater value than any 
conceivable manipulation of statistical methods. Some business 
cycle research institutes are imbued with the erroneous idea that 
they are conducting impartial factual research, free of any preju- 
dice due to theoretical considerations. In fact, all their work rests 
on the groundwork of the Circulation Credit Theory. In spite of 
the reluctance which exists today against logical reasoning in 
economics and against thinking problems and theories through 
to their ultimate conclusions, a great deal would be gained if it 
were decided to base cyclical policy deliberately on this theory. 
Then, one would know that every expansion of circulation credit 
must be counteracted in order to even out the waves of the busi- 
ness cycle. Then, a force operating on one side to reduce the 
purchasing power of money would be offset from the other side. 
The difficulties, due to the impossibility of finding any method 
for measuring changes in purchasing power, cannot be over- 
come. It is impossible to realize the ideal of either a monetary 
unit of unchanging value or economic stability. However, once it 
is resolved to forgo the artificial stimulation of business activity 
by means of banking policy, fluctuations in business conditions 
will surely be substantially reduced. To be sure this will mean giv- 
ing up many a well-loved slogan, for example, “easy money” to 
encourage credit transactions. However, a still greater ideological 
sacrifice than that is called for. The desire to reduce the interest 
rate in any way must also be abandoned. 

140 — The Causes of the Economic Crisis 

It has already been pointed out that events would have turned 
out very differently if there had been no deviation from the prin- 
ciple of complete freedom in banking and if the issue of fiduciary 
media had been in no way exempted from the rules of commer- 
cial law. It may be that a final solution of the problem can be 
arrived at only through the establishment of completely free 
banking. However, the credit structure which has been devel- 
oped by the continued effort of many generations cannot be 
transformed with one blow. Future generations, who will have 
recognized the basic absurdity of all interventionist attempts, will 
have to deal with this question also. However, the time is not yet 
ripe — not now nor in the immediate future. 


Control of the Money Market 

1. International Competition or Cooperation 

There are many indications that public opinion has recog- 
nized the significance of the role banks play in initiating the cycle 
by their expansion of circulation credit. If this view should actu- 
ally prevail, then the previous popularity of efforts aimed at 
artificially reducing the interest rate on loans would disappear. 
Banks that wanted to expand their issue of fiduciary media would 
no longer be able to count on public approval or government 
support. They would become more careful and more temperate. 
That would smooth out the waves of the cycle and reduce the 
severity of the sudden shift from rise to fall. 

However, there are some indications which seem to contradict 
this view of public opinion. Most important among these are the 
attempts or, more precisely, the reasoning which underlies the 
attempts to bring about international cooperation among the 
banks of issue. 

Monetary Stabilization and Cyclical Policy — 141 

In speculative periods of the past, the very fact that the banks 
of the various countries did not work together systematically, and 
according to agreement, constituted a most effective brake. With 
closely-knit international economic relations, the expansion of 
circulation credit could only become universal if it were an inter- 
national phenomenon. Accordingly, lacking any international 
agreement, individual banks, fearing a large outflow of capital, 
took care in setting their interest rates not to lag far below the 
rates of the banks of other countries. Thus, in response to inter- 
est rate arbitrage and any deterioration in the balance of trade, 
brought about by higher prices, an exodus of loan money to other 
countries would, for one thing, have impaired the ratio of the 
bank’s cover, as a result of foreign claims on their gold and foreign 
exchange which such conditions impose on the bank of issue. 
The bank, obliged to consider its solvency, would then be forced 
to restrict credit. In addition, this impairment of the ever-shifting 
balance of payments would create a shortage of funds on the 
money market which the banks would be powerless to combat. 
The closer the economic connections among peoples become, 
the less possible it is to have a national boom. The business cli- 
mate becomes an international phenomenon. 

However, in many countries, especially in the German Reich, 
the view has frequently been expressed by friends of “cheap 
money” that it is only the gold standard that forces the bank of 
issue to consider interest rates abroad in determining its own 
interest policy. According to this view, if the bank were free of 
this shackle, it could then better satisfy the demands of the 
domestic money market, to the advantage of the national econ- 
omy. With this view in mind, there were in Germany advocates of 
bimetallism, as well as of a gold premium policy . 49 In Austria, 
there was resistance to formalizing legally the de facto practice of 
redeeming its notes. 

It is easy to see the fallacy in this doctrine that only the tie of 
the monetary unit to gold keeps the banks from reducing inter- 
est rates at will. Even if all ties with the gold standard were 

49 [See above p. 41, note 26.— Ed.] 

142 — The Causes of the Economic Crisis 

broken, this would not have given the banks the power to lower 
the interest rate, below the height of the “natural” interest rate, 
with impunity. To be sure, the paper standard would have per- 
mitted them to continue the expansion of circulation credit 
without hesitation, because a bank of issue, relieved of the obli- 
gation of redeeming its notes, need have no fear with respect to 
its solvency. Still, the increase in notes would have led first to 
price increases and consequently to a deterioration in the rate of 
exchange. Second, the crisis would have come — later, to be sure, 
but all the more severely. 

If the banks of issue were to consider seriously making agree- 
ments with respect to discount policy, this would eliminate one 
effective check. By acting in unison, the banks could extend more 
circulation credit than they do now, without any fear that the 
consequences would lead to a situation which produces an exter- 
nal drain of funds from the money market. To be sure, if this 
concern with the situation abroad is eliminated, the banks are 
still not always in a position to reduce the money rate of interest 
below its “natural” rate in the long run. However, the difference 
between the two interest rates can be maintained longer, so that 
the inevitable result — malinvestment of capital — appears on a 
larger scale. This must then intensify the unavoidable crisis and 
deepen the depression. 

So far, it is true, the banks of issue have made no significant 
agreements on cyclical policy. Nevertheless, efforts aimed at such 
agreements are certainly being proposed on every side. 

2. “Boom” Promotion Problems 

Another dangerous sign is that the slogan concerning the need 
to “control the money market,” through the banks of issue, still 
retains its prestige. 

Given the situation, especially as it has developed in Europe, 
only the central banks are entitled to issue notes. Under that 
system, attempts to expand circulation credit universally can only 
originate with the central bank of issue. Every venture on the part 
of private banks, against the wish or the plan of the central bank, 

Monetary Stabilization and Cyclical Policy — 143 

is doomed from the very beginning. Even banking techniques, 
learned from the Anglo-Saxons, are of no service to private banks, 
since the opportunity for granting credit, by opening bank 
deposits, is insignificant in countries where the use of checks 
(except for central bank clearings and the circulation of postal 
checks) is confined to a narrow circle in the business world. 
However, if the central bank of issue embarks upon a policy of 
credit expansion and thus begins to force down the rate of inter- 
est, it may be advantageous for the largest private banks to follow 
suit and expand the volume of circulation credit they grant too. 
Such a procedure has still a further advantage for them. It involves 
them in no risk. If confidence is shaken during the crisis, they can 
survive the critical stage with the aid of the bank of issue. 

However, the bank of issue’s credit expansion policy certainly 
offers a large number of banks a profitable field for speculation — 
arbitrage in the loan rates of interest. They seek to profit from the 
shifting ratio between domestic and foreign interest rates by 
investing domestically obtained funds in short term funds 
abroad. In this process, they are acting in opposition to the dis- 
count policy of the bank of issue and hurting the alleged interests 
of those groups which hope to benefit from the artificial reduc- 
tion of the interest rate and from the boom it produces. The 
ideology, which sees salvation in every effort to lower the interest 
rate and regards expansion of circulation credit as the best 
method of attaining this goal, is consistent with the policy of 
branding the actions of the interest rate arbitrageur as scandalous 
and disgraceful, even as a betrayal of the interests of his own peo- 
ple to the advantage of foreigners. The policy of granting the 
banks of issue every possible assistance in the fight against these 
speculators is also consistent with this ideology. Both government 
and bank of issue seek to intimidate the malefactors with threats, 
to dissuade them from their plan. In the liberal 50 countries of 
western Europe, at least in the past, little could be accomplished 
by such methods. In the interventionist countries of middle and 

50 [See above p. 68, note 11.— Ed.] 

144 — The Causes of the Economic Crisis 

eastern Europe, attempts of this kind have met with greater suc- 

It is easy to see what lies behind this effort of the bank of issue 
to “control” the money market. The bank wants to prevent its 
credit expansion policy, aimed at reducing the interest rate, from 
being impeded by consideration of relatively restrictive policies 
followed abroad. It seeks to promote a domestic boom without 
interference from international reactions. 

3. Drive for Tighter Controls 

According to the prevailing ideology, however, there are still 
other occasions when the banks of issue should have stronger con- 
trol over the money market. If the interest rate arbitrage, resulting 
from the expansion of circulation credit, has led, for the time 
being, only to a withdrawal of funds from the reserves of the issu- 
ing bank, and that bank, disconcerted by the deterioration of the 
security behind its notes, has proceeded to raise its discount rate, 
there may still be, under certain conditions, no cause for the loan 
rate to rise on the open money market. As yet no funds have been 
withdrawn from the domestic market. The gold exports came 
from the bank’s reserves, and the increase in the discount rate has 
not led to a reduction in the credits granted by the bank. It takes 
time for loan funds to become scarce as a result of the fact that 
some commercial paper, which would otherwise have been offered 
to the bank for discount, is disposed of on the open market. The 
issuing bank, however, does not want to wait so long for its maneu- 
ver to be effective. Alarmed at the state of its gold and foreign 
exchange assets, it wants prompt relief. To accomplish this, it must 
try to make money scarce on the market. It generally tries to bring 
this about by appearing itself as a borrower on the market. 

Another case, when control of the money market is contested, 
concerns the utilization of funds made available to the market by 
the generous discount policy. The dominant ideology favors 
“cheap money.” It also favors high commodity prices, but not 
always high stock market prices. The moderated interest rate is 
intended to stimulate production and not to cause a stock mar- 
ket boom. However, stock prices increase first of all. At the 

Monetary Stabilization and Cyclical Policy — 145 

outset, commodity prices are not caught up in the boom. There 
are stock exchange booms and stock exchange profits. Yet, the 
“producer” is dissatisfied. He envies the “speculator” his “easy 
profit.” Those in power are not willing to accept this situation. 
They believe that production is being deprived of money which 
is flowing into the stock market. Besides, it is precisely in the 
stock market boom that the serious threat of a crisis lies hidden. 

Therefore, the aim is to withdraw money from stock exchange 
loans in order to inject it into the “economy.” Trying to do this 
simply by raising the interest rate offers no special attraction. 
Such a rise in the interest rate is certainly unavoidable in the end. 
It is only a question of whether it comes sooner or later. 
Whenever the interest rate rises sufficiently, it brings an end to 
the business boom. Therefore, other measures are tried to trans- 
fer funds from the stock market into production, without 
changing the cheap rate for loans. The bank of issue exerts pres- 
sure on borrowers to influence the use made of the sums loaned 
out. Or else it proceeds directly to set different terms for credit 
depending on its use. 

Thus we can see what it means if the central bank of issue aims 
at domination of the money market. Either the expansion of cir- 
culation credit is freed from the limitations which would 
eventually restrict it or the boom is shifted by certain measures 
along a course different from the one it would otherwise have fol- 
lowed. Thus, the pressure for “control of the money market” 
specifically envisions the encouragement of the boom — the 
boom which must end in a crisis. If a cyclical policy is to be fol- 
lowed to eliminate crises, this desire, the desire to control and 
dominate the money market, must be abandoned. 

If it were seriously desired to counteract price increases 
resulting from an increase in the quantity of money — due to an 
increase in the mining of gold, for example — by restricting circu- 
lation credit, the central banks of issue would borrow more on 
the market. Paying off these obligations later could hardly be 
described as “controlling the money market.” For the bank of 
issue, the restriction of circulation credit means the renunciation 
of profits. It may even mean losses. 

146 — The Causes of the Economic Crisis 

Moreover, such a policy can be successful only if there is 
agreement among the banks of issue. If restriction were practiced 
by the central bank of one country only, it would result in rela- 
tively high costs of borrowing money within that country. The 
chief consequence of this would then be that gold would flow in 
from abroad. Insofar as this is the goal sought by the cooperation 
of the banks, it certainly cannot be considered a dangerous step 
in the attempt toward a policy of evening out the waves of the 
business cycle. 


Business Forecasting For Cyclical 
Policy And the Businessman 

1. Contributions of Business Cycle Research 

The popularity enjoyed by contemporary business cycle 
research, the development of which is due above all to American 
economic researchers, derives from exaggerated expectations as 
to its usefulness in practice. With its help, it had been hoped to 
mechanize banking policy and business activity. It had been 
hoped that a glance at the business barometer would tell busi- 
nessmen and those who determine banking policy how to act. 

At present, this is certainly out of the question. It has already 
been emphasized often enough that the results of business cycle 
studies have only described past events and that they may be 
used for predicting future developments only on the basis of 
extremely inadequate principles. However — and this is not suffi- 
ciently noted — these principles apply solely on the assumption 
that the ideology calling for expansion of circulation credit has 
not lost its standing in the field of economic and banking policy. 
Once a serious start is made at directing cyclical policy toward the 
elimination of crises, the power of this ideology is already dissi- 

Monetary Stabilization and Cyclical Policy — 147 

Nevertheless, one broad field remains for the employment of 
the results of contemporary business cycle studies. They should 
indicate to the makers of banking policy when the interest rate 
must be raised to avoid instigating credit expansion. If the study 
of business conditions were clear on this point and gave answers 
admitting of only one interpretation, so that there could be only 
one opinion, not only as to whether but also as to when and how 
much to increase the discount rate, then the advantage of such 
studies could not be rated highly enough. However, this is not the 
case. Everything that the observation of business conditions con- 
tributes in the form of manipulated data and material can be 
interpreted in various ways. 

Even before the development of business barometers, it was 
already known that increases in stock market quotations and 
commodity prices, a rise in profits on raw materials, a drop in 
unemployment, an increase in business orders, the selling off of 
inventories, and so on, signified a boom. The question is, when 
should, or when must, the brakes be applied. However, no busi- 
ness cycle institute answers this question straightforwardly and 
without equivocation. What should be done will always depend 
on an examination of the driving forces which shape business 
conditions and on the objectives set for cyclical policy. Whether 
the right moment for action is seized can never be decided except 
on the basis of a careful observation of all market phenomena. 
Moreover, it has never been possible to answer this question in 
any other way. The fact that we now know how to classify and 
describe the various market data more clearly than before does 
not make the task essentially any easier. 

A glance at the continuous reports on the economy and the 
stock market in the large daily newspapers and in the economic 
weeklies, which appeared from 1840 to 1910, shows that 
attempts have been made for decades to draw conclusions from 
events of the most recent past, on the basis of empirical rules, as 
to the shape of the immediate future. If we compare the statisti- 
cal groundwork used in these attempts with those now at our 
disposal, then it is obvious that we have recourse to more data 
today. We also understand better how to organize this material, 

148 — The Causes of the Economic Crisis 

how to arrange it clearly and interpret it for graphic presentation. 
However, we can by no means claim, with the modern methods 
of studying business conditions, to have embarked on some new 

2. Difficulties of Precise Prediction 

No businessman may safely neglect any available source of 
information. Thus no businessman can refuse to pay close atten- 
tion to newspaper reports. Still diligent newspaper reading is no 
guarantee of business success. If success were that easy, what 
wealth would the journalists have already amassed! In the busi- 
ness world, success depends on comprehending the situation 
sooner than others do — and acting accordingly. What is recog- 
nized as “fact” must first be evaluated correctly to make it useful 
for an undertaking. Precisely this is the problem of putting the- 
ory into practice. 

A prediction, which makes judgments which are qualitative 
only and not quantitative, is practically useless even if it is even- 
tually proved right by the later course of events. There is also the 
crucial question of timing. Decades ago, Herbert Spencer recog- 
nized, with brilliant perception, that militarism, imperialism, 
socialism and interventionism must lead to great wars, severe 
wars. However, anyone who had started about 1890, to speculate 
on the strength of that insight on a depreciation of the bonds of 
the Three Empires 51 would have sustained heavy losses. Large 
historical perspectives furnish no basis for stock market specula- 
tions which must be reviewed daily, weekly, or monthly at least. 

It is well known that every boom must one day come to an 
end. The businessman’s situation, however, depends on knowing 
exactly when and where the break will first appear. No economic 
barometer can answer these questions. An economic barometer 
only furnishes data from which conclusions may be drawn. Since 
it is still possible for the central bank of issue to delay the start of 
the catastrophe with its discount policy, the situation depends 

51 Austria-Hungary, Germany, and Russia. [See above p. 130, note 45.— Ed.] 

Monetary Stabilization and Cyclical Policy — 149 

chiefly on making judgments as to the conduct of these authori- 
ties. Obviously, all available data fail at this point. 

But once public opinion is completely dominated by the view 
that the crisis is imminent and businessmen act on this basis, 
then it is already too late to derive business profit from this 
knowledge. Or even merely to avoid losses. For then the panic 
breaks out. The crisis has come. 


The Aims and Method of Cyclical Policy 

1. Revised Currency School Theory 

Without doubt, expanding the sphere of scientific investiga- 
tion from the narrow problem of the crisis into the broader 
problem of the cycle represents progress. 52 However, it was cer- 
tainly not equally advantageous for political policies. Their scope 
was broadened. They began to aspire to more than was feasible. 

The economy could be organized so as to eliminate cyclical 
changes only if (1) there were something more than muddled 
thinking behind the concept that changes in the value of the 
monetary unit can be measured, and (2) it were possible to deter- 
mine in advance the extent of the effect which accompanies a 
definite change in the quantity of money and fiduciary media. As 
these conditions do not prevail, the goals of cyclical policy must 
be more limited. However, even if only such severe shocks as 
those experienced in 1857, 1873, 1900/01 and 1907, could be 
avoided in the future, a great deal would have been accomplished. 

52 Also, as a result of this, it became easier to distinguish crises originat- 
ing from definite causes (wars and political upheavals, violent convulsions 
of nature, changes in the shape of supply or demand) from cyclically-recur- 
ring crises. 

ISO — The Causes of the Economic Crisis 

The most important prerequisite of any cyclical policy, no 
matter how modest its goal may be, is to renounce every attempt 
to reduce the interest rate, by means of banking policy, below the 
rate which develops on the market. That means a return to the 
theory of the Currency School, which sought to suppress all 
future expansion of circulation credit and thus all further cre- 
ation of fiduciary media. However, this does not mean a return to 
the old Currency School program, the application of which was 
limited to banknotes. Rather it means the introduction of a new 
program based on the old Currency School theory, but expanded 
in the light of the present state of knowledge to include fiduciary 
media issued in the form of bank deposits. 

The banks would be obliged at all times to maintain metallic 
backing for all notes — except for the sum of those outstanding 
which are not now covered by metal — equal to the total sum of the 
notes issued and bank deposits opened. That would mean a com- 
plete reorganization of central bank legislation. The banks of issue 
would have to return to the principles of Peel’s Bank Act, but with 
the provisions expanded to cover also bank balances subject to 
check. The same stipulations with respect to reserves must also be 
applied to the large national deposit institutions, especially the 
postal savings . 53 Of course, for these secondary banks of issue, the 
central bank reserves for their notes and deposits would be the 
equivalent of gold reserves. In those countries where checking 
accounts at private commercial banks play an important role in 
trade — notably the United States and England — the same obliga- 
tion must be exacted from those banks also. 

By this act alone, cyclical policy would be directed in earnest 
toward the elimination of crises. 

53 [The Post Office Savings Institution, established in Austria in the 1880s 
and copied in several other European countries, played a significant, if limited, 
role in monetary affairs. See Mises’s comments in Human Action, pp. 445-46. 

Monetary Stabilization and Cyclical Policy — 151 

2. “Price Level” Stabilization 

Under present circumstances, it is out of the question, in the 
foreseeable future, to establish complete “free banking” and place 
all banking transactions, including the granting of credit, under 
ordinary commercial law. Those who speak and write today on 
behalf of “stabilization,” “maintenance of purchasing power” and 
“elimination of the trade cycle,” can certainly not call this more 
limited approach “extreme.” On the contrary! They will reject this 
suggestion as not going far enough. They are demanding much 
more. In their view, the “price level” should be maintained by 
countering rising prices with a restriction in the circulation of 
fiduciary media and, similarly, countering falling prices by the 
expansion of fiduciary media. 

The arguments that may be advanced in favor o/this modest 
program have already been set forth above in the first part of this 
work. In our judgment, the arguments which militate against all 
monetary manipulation are so great that placing decisions as to the 
formation of purchasing power in the hands of banking officials, 
parliaments and governments, thus making it subject to shifting 
political influences, must be avoided. The methods available for 
measuring changes in purchasing power are necessarily defective. 
The effect of the various maneuvers, intended to influence pur- 
chasing power, cannot be quantitatively established— neither in 
advance nor even after they have taken place. Thus proposals 
which amount only to making approximate adjustments in pur- 
chasing power must be considered completely impractical. 

Nothing more will be said here concerning the fundamental 
absurdity of the concept of “stable purchasing power” in a chang- 
ing economy. This has already been discussed at some length. For 
practical economic policy, the only problem is what inflationist 
or restrictionist measures to consider for the partial adjustment 
of severe price declines or increases. Such measures, carried out 
in stages, step by step, through piecemeal international agree- 
ments, would benefit either creditors or debtors. However, one 
question remains: Whether, in view of the conflicts among inter- 
ests, agreements on this issue could be reached among nations. 

152 — The Causes of the Economic Crisis 

The viewpoints of creditors and debtors will no doubt differ 
widely, and these conflicts of interest will complicate still more 
the manipulation of money internationally, than on the national 

3. International Complications 

It is also possible to consider monetary manipulation as an 
aspect of national economic policy, and take steps to regulate the 
value of money independently, without reference to the interna- 
tional situation. According to Keynes , 54 if there is a choice 
between stabilization of prices and stabilization of the foreign 
exchange rate, the decision should be in favor of price stabiliza- 
tion and against stabilization of the rate of exchange. However, a 
nation which chose to proceed in this way would create interna- 
tional complications because of the repercussions its policy 
would have on the content of contractual obligations. 

For example, if the United States were to raise the purchasing 
power of the dollar over that of its present gold parity, the inter- 
ests of foreigners who owed dollars would be very definitely 
affected as a result. Then again, if debtor nations were to try to 
depress the purchasing power of their monetary unit, the inter- 
ests of creditors would be impaired. Irrespective of this, every 
change in value of a monetary unit would unleash influences on 
foreign trade. A rise in its value would foster increased imports, 
while a fall in its value would be recognized as the power to 
increase exports. 

In recent generations, consideration of these factors has led to 
pressure for a single monetary standard based on gold. If this sit- 
uation is ignored, then it will certainly not be possible to fashion 
monetary value so that it will generally be considered satisfac- 
tory. In view of the ideas prevailing today with respect to trade 
policy, especially in connection with foreign relations, a rising 
value for money is not considered desirable, because of its power 
to promote imports and to hamper exports. 

54 John Maynard Keynes, A Tract on Monetary Reform (London, 1923; 
New York, 1924), pp. 156ff. 

Monetary Stabilization and Cyclical Policy — 153 

Attempts to introduce a national policy, so as to influence 
prices independently of what is happening abroad, while still 
clinging to the gold standard and the corresponding rates of 
exchange, would be completely unworkable. There is no need to 
say any more about this. 

4. The Future 

The obstacles, which militate against a policy aimed at the com- 
plete elimination of cyclical changes, are truly considerable. For 
that reason, it is not very likely that such new approaches to mon- 
etary and banking policy, that limit the creation of fiduciary media, 
will be followed. It will probably not be resolved to prohibit entirely 
the expansion of fiduciary media. Nor is it likely that expansion 
will be limited to only the quantities sufficient to counteract a def- 
inite and pronounced trend toward generally declining prices. 
Perplexed as to how to evaluate the serious political and economic 
doubts which are raised in opposition to every kind of manipula- 
tion of the value of money, the people will probably forgo decisive 
action and leave it to the central bank managers to proceed, case 
by case, at their own discretion. Just as in the past, cyclical policy 
of the near future will be surrendered into the hands of the men 
who control the conduct of the great central banks and those who 
influence their ideas, i.e., the moulders of public opinion. 

Nevertheless, the cyclical policy of the future will differ appre- 
ciably from its predecessor. It will be knowingly based on the 
Circulation Credit Theory of the Trade Cycle. The hopeless 
attempt to reduce the loan rate indefinitely by continuously 
expanding circulation credit will not be revived in the future. It 
may be that the quantity of fiduciary media will be intentionally 
expanded or contracted in order to influence purchasing power. 
However, the people will no longer be under the illusion that 
technical banking procedures can make credit cheaper and thus 
create prosperity without its having repercussions. 

The only way to do away with, or even to alleviate, the periodic 
return of the trade cycle — with its denouement, the crisis — is to 
reject the fallacy that prosperity can be produced by using bank- 
ing procedures to make credit cheap. 


The Causes of the Economic Crisis: 

An Address (19 3 1) 


The Nature and Role of the Market 

1. The Marxian “Anarchy of Production” Myth 

T he Marxian critique censures the capitalistic social order 
for the anarchy and planlessness of its production meth- 
ods. Allegedly, every entrepreneur produces blindly, 
guided only by his desire for profit, without any concern as to 
whether his action satisfies a need. Thus, for Marxists, it is not 
surprising if severe disturbances appear again and again in the 
form of periodical economic crises. They maintain it would be 
futile to fight against all this with capitalism. It is their contention 
that only socialism will provide the remedy by replacing the anar- 
chistic profit economy with a planned economic system aimed at 
the satisfaction of needs. 

Strictly speaking, the reproach that the market economy is 
“anarchistic” says no more than that it is just not socialistic. That 
is, the actual management of production is not surrendered to 

[Die Ursachen der Wirtschaftskrise: Ein Vortrag (Tubingen: J.C.B. Mohr, 
Paul Siebeck, 1931). Presented February 28, 1931, at Teplitz-Schonau, 
Czechoslovakia, before an assembly of German industrialists (Deutscher 
Hauptverband der Industrie).— Ed.] 


156 — The Causes of the Economic Crisis 

a central office which directs the employment of all factors of 
production, but this is left to entrepreneurs and owners of the 
means of production. Calling the capitalistic economy “anarchis- 
tic,” therefore, means only that capitalistic production is not a 
function of governmental institutions. 

Yet, the expression “anarchy” carries with it other connota- 
tions. We usually use the word “anarchy” to refer to social 
conditions in which, for lack of a governmental apparatus of force 
to protect peace and respect for the law, the chaos of continual 
conflict prevails. The word “anarchy,” therefore, is associated 
with the concept of intolerable conditions. Marxian theorists 
delight in using such expressions. Marxian theory needs the 
implications such expressions give to arouse the emotional sym- 
pathies and antipathies that are likely to hinder critical analysis. 
The “anarchy of production” slogan has performed this service to 
perfection. Whole generations have permitted it to confuse 
them. It has influenced the economic and political ideas of all 
currently active political parties and, to a remarkable extent, even 
those parties which loudly proclaim themselves anti-Marxist. 

2. The Role and Rule of Consumers 

Even if the capitalistic method of production were “anarchis- 
tic,” i.e., lacking systematic regulation from a central office, and 
even if individual entrepreneurs and capitalists did, in the hope of 
profit, direct their actions independently of one another, it is still 
completely wrong to suppose they have no guide for arranging 
production to satisfy need. It is inherent in the nature of the cap- 
italistic economy that, in the final analysis, the employment of 
the factors of production is aimed only toward serving the wishes 
of consumers. In allocating labor and capital goods, the entrepre- 
neurs and the capitalists are bound, by forces they are unable to 
escape, to satisfy the needs of consumers as fully as possible, 
given the state of economic wealth and technology. Thus, the 
contrast drawn between the capitalistic method of production, as 
production for profit, and the socialistic method, as production 
for use, is completely misleading. In the capitalistic economy, it is 
consumer demand that determines the pattern and direction of 

The Causes of the Economic Crisis: An Address — 157 

production, precisely because entrepreneurs and capitalists must 
consider the profitability of their enterprises. 

An economy based on private ownership of the factors of pro- 
duction becomes meaningful through the market. The market 
operates by shifting the height of prices so that again and again 
demand and supply will tend to coincide. If demand for a good 
goes up, then its price rises, and this price rise leads to an 
increase in supply. Entrepreneurs try to produce those goods the 
sale of which offers them the highest possible gain. They expand 
production of any particular item up to the point at which it 
ceases to be profitable. If the entrepreneur produces only those 
goods whose sale gives promise of yielding a profit, this means 
that they are producing no commodities for the manufacture of 
which labor and capital goods must be used which are needed for 
the manufacture of other commodities more urgently desired by 

In the final analysis, it is the consumers who decide what shall 
be produced, and how. The law of the market compels entrepre- 
neurs and capitalists to obey the orders of consumers and to 
fulfill their wishes with the least expenditure of time, labor and 
capital goods. Competition on the market sees to it that entre- 
preneurs and capitalists, who are not up to this task, will lose 
their position of control over the production process. If they can- 
not survive in competition, that is, in satisfying the wishes of 
consumers cheaper and better, then they suffer losses which 
diminish their importance in the economic process. If they do 
not soon correct the shortcomings in the management of their 
enterprise and capital investment, they are eliminated completely 
through the loss of their capital and entrepreneurial position. 
Henceforth, they must be content as employees with a more 
modest role and reduced income. 

3. Production for Consumption 

The law of the market applies to labor also. Like other factors 
of production, labor is also valued according to its usefulness in 
satisfying human wants. Its price, the wage rate, is a market 
phenomenon like any other market phenomenon, determined by 

158 — The Causes of the Economic Crisis 

supply and demand, by the value the product of labor has in the 
eye of consumers. By shifting the height of wages, the market 
directs workers into those branches of production in which they 
are most urgently needed. Thus the market supplies to each type 
of employment that quality and quantity of labor needed to sat- 
isfy consumer wants in the best possible way. 

In the feudal society, men became rich by war and conquest 
and through the largesse of the sovereign ruler. Men became 
poor if they were defeated in battle or if they fell from the 
monarch’s good graces. In the capitalistic society, men become 
rich — directly as the producer of consumers’ goods, or indi- 
rectly as the producer of raw materials and semi-produced 
factors of production — by serving consumers in large numbers. 
This means that men who become rich in the capitalistic soci- 
ety are serving the people. The capitalistic market economy is a 
democracy in which every penny constitutes a vote. The wealth 
of the successful businessman is the result of a consumer 
plebiscite. Wealth, once acquired, can be preserved only by 
those who keep on earning it anew by satisfying the wishes of 

The capitalistic social order, therefore, is an economic democ- 
racy in the strictest sense of the word. In the last analysis, all 
decisions are dependent on the will of the people as consumers. 
Thus, whenever there is a conflict between consumers’ views and 
those of the business managers, market pressures assure that the 
views of the consumers win out eventually. This is certainly 
something very different from the pseudo-economic democracy 
toward which the labor unions are aiming. In such a system as 
they propose, the people are supposed to direct production as 
producers, not as consumers. They would exercise influence, not 
as buyers of products, but as sellers of labor, that is, as sellers of 
one of the factors of production. If this system were carried out, 
it would disorganize the entire production apparatus and thus 
destroy our civilization. The absurdity of this position becomes 
apparent simply upon considering that production is not an end 
in itself. Its purpose is to serve consumption. 

The Causes of the Economic Crisis: An Address — 159 

4. The Perniciousness of a “Producers’ Policy” 

Under pressure of the market, entrepreneurs and capitalists 
must order production so as to carry out the wishes of 
consumers. The arrangements they make and what they ask of 
workers is always determined by the need to satisfy the most 
urgent wants of consumers. It is precisely this which guarantees 
that the will of the consumer shall be the only guideline for busi- 
ness. Yet capitalism is usually reproached for placing the logic of 
expediency above sentiment and arranging things in the econ- 
omy dispassionately and impersonally for monetary profit only. It 
is because the market compels the entrepreneur to conduct his 
business so that he derives from it the greatest possible return 
that the wants of consumers are covered in the best and cheapest 
way. If potential profit were no longer taken into consideration by 
enterprises, but instead the workers’ wishes became the criterion, 
so that work was arranged for their greatest convenience, then 
the interests of consumers would be injured. If the entrepreneur 
aims at the highest possible profit, he performs a service to soci- 
ety in managing an enterprise. Whoever hinders him from doing 
this, in order to give preference to considerations other than 
those of business profits, acts against the interests of society and 
imperils the satisfaction of consumer needs. 

Workers and consumers are, of course, identical. If we distin- 
guish between them, we are only differentiating mentally 
between their respective functions within the economic frame- 
work. We should not let this lead us into the error of thinking 
they are different groups of people. The fact that entrepreneurs 
and capitalists also are consuming plays a less important role 
quantitatively; for the market economy, the significant consump- 
tion is mass consumption. Directly or indirectly, capitalistic 
production serves primarily the consumption of the masses. The 
only way to improve the situation of the consumer, therefore, is 
to make enterprises still more productive, or as people may say 
today, to “rationalize” still further. Only if one wants to reduce 
consumption, should one urge what is known as “producers’ pol- 
icy” — specifically the adoption of those measures which place the 
interests of producers over those of consumers. 

160 — The Causes of the Economic Crisis 

Opposition to the economic laws which the market decrees 
for production must always be at the expense of consumption. 
This should be kept in mind whenever interventions are advo- 
cated to free producers from the necessity of complying with the 

The market processes give meaning to the capitalistic econ- 
omy. They place entrepreneurs and capitalists in the service of 
satisfying the wants of consumers. If the workings of these com- 
plex processes are interfered with, then disturbances are brought 
about which hamper the adjustment of supply to demand and 
lead production astray, along paths which keep them from attain- 
ing the goal of economic action — i.e., the satisfaction of wants. 

These disturbances constitute the economic crisis. 


Cyclical Changes in Business Conditions 

1. Role of Interest Rates 

In our economic system, times of good business commonly 
alternate more or less regularly with times of bad business. 
Decline follows economic upswing, upswing follows decline, and 
so on. The attention of economic theory has quite understand- 
ably been greatly stimulated by this problem of cyclical changes 
in business conditions. In the beginning, several hypotheses were 
set forth, which could not stand up under critical examination. 
However, a theory of cyclical fluctuations was finally developed 
which fulfilled the demands legitimately expected from a scien- 
tific solution to the problem. This is the circulation credit theory, 
usually called the monetary theory of the trade cycle. This theory 
is generally recognized by science. All cyclical policy measures, 
which are taken seriously, proceed from the reasoning which lies 
at the root of this theory. 

The Causes of the Economic Crisis: An Address — 161 

According to the circulation credit theory (monetary theory 
of the trade cycle), cyclical changes in business conditions stem 
from attempts to reduce artificially the interest rates on loans 
through measures of banking policy — expansion of bank credit 
by the issue or creation of additional fiduciary media (that is 
banknotes and/or checking deposits not covered 100 percent by 
gold). On a market, which is not disturbed by the interference of 
such an “inflationist” banking policy, interest rates develop at 
which the means are available to carry out all the plans and enter- 
prises that are initiated. Such unhampered market interest rates 
are known as “natural” or “static” interest rates. If these interest 
rates were adhered to, then economic development would pro- 
ceed without interruption — except for the influence of natural 
cataclysms or political acts such as war, revolution, and the like. 
The fact that economic development follows a wavy pattern must 
be attributed to the intervention of the banks through their inter- 
est rate policy. 

The point of view prevails generally among politicians, busi- 
ness people, the press and public opinion that reducing the 
interest rates below those developed by market conditions is a 
worthy goal for economic policy, and that the simplest way to 
reach this goal is through expanding bank credit. Under the 
influence of this view, the attempt is undertaken, again and again, 
to spark an economic upswing through granting additional loans. 
At first, to be sure, the result of such credit expansion comes up 
to expectations. Business is revived. An upswing develops. 
However, the stimulating effect emanating from the credit 
expansion cannot continue forever. Sooner or later, a business 
boom created in this way must collapse. 

At the interest rates which developed on the market, before 
any interference by the banks through the creation of additional 
circulation credit, only those enterprises and businesses 
appeared profitable for which the needed factors of production 
were available in the economy. The interest rates are reduced 
through the expansion of credit, and then some businesses, 
which did not previously seem profitable, appear to be profitable. 
It is precisely the fact that such businesses are undertaken that 

162 — The Causes of the Economic Crisis 

initiates the upswing. However, the economy is not wealthy 
enough for them. The resources they need for completion are not 
available. The resources they need must first be withdrawn from 
other enterprises. If the means had been available, then the credit 
expansion would not have been necessary to make the new proj- 
ects appear possible. 

2. The Sequel of Credit Expansion 

Credit expansion cannot increase the supply of real goods. It 
merely brings about a rearrangement. It diverts capital invest- 
ment away from the course prescribed by the state of economic 
wealth and market conditions. It causes production to pursue 
paths which it would not follow unless the economy were to 
acquire an increase in material goods. As a result, the upswing 
lacks a solid base. It is not real prosperity. It is illusory prosperity. 
It did not develop from an increase in economic wealth. Rather, 
it arose because the credit expansion created the illusion of such 
an increase. Sooner or later it must become apparent that this 
economic situation is built on sand. 

Sooner or later, credit expansion, through the creation of 
additional fiduciary media, must come to a standstill. Even if the 
banks wanted to, they could not carry on this policy indefinitely, 
not even if they were being forced to do so by the strongest pres- 
sure from outside. The continuing increase in the quantity of 
fiduciary media leads to continual price increases. Inflation can 
continue only so long as the opinion persists that it will stop in 
the foreseeable future. However, once the conviction gains a 
foothold that the inflation will not come to a halt, then a panic 
breaks out. In evaluating money and commodities, the public 
takes anticipated price increases into account in advance. As a 
consequence, prices race erratically upward out of all bounds. 
People turn away from using money which is compromised by 
the increase in fiduciary media. They “flee” to foreign money, 
metal bars, “real values,” barter. In short, the currency breaks 

The policy of expanding credit is usually abandoned well 
before this critical point is reached. It is discontinued because of 

The Causes of the Economic Crisis: An Address — 163 

the situation which develops in international trade relations and 
also, especially, because of experiences in previous crises, which 
have frequently led to legal limitations on the right of the central 
banks to issue notes and create credit. In any event, the policy of 
expanding credit must come to an end — if not sooner due to a 
turnabout by the banks, then later in a catastrophic breakdown. 
The sooner the credit expansion policy is brought to a stop, the 
less harm will have been done by the misdirection of entrepre- 
neurial activity, the milder the crisis and the shorter the following 
period of economic stagnation and general depression. 

The appearance of periodically recurring economic crises is 
the necessary consequence of repeatedly renewed attempts to 
reduce the “natural” rates of interest on the market by means of 
banking policy. The crises will never disappear so long as men 
have not learned to avoid such pump- priming, because an artifi- 
cially stimulated boom must inevitably lead to crisis and 


The Present Crisis 

The crisis from which we are now suffering is also the out- 
come of a credit expansion. The present crisis is the unavoidable 
sequel to a boom. Such a crisis necessarily follows every boom 
generated by the attempt to reduce the “natural rate of interest” 
through increasing the fiduciary media. However, the present 
crisis differs in some essential points from earlier crises, just as 
the preceding boom differed from earlier economic upswings. 

The most recent boom period did not run its course com- 
pletely, at least not in Europe. Some countries and some 
branches of production were not generally or very seriously 
affected by the upswing which, in many lands, was quite turbu- 
lent. A bit of the previous depression continued, even into the 
upswing. On that account — in line with our theory and on the 

164 — The Causes of the Economic Crisis 

basis of past experience — one would assume that this time the 
crisis will be milder. However, it is certainly much more severe 
than earlier crises and it does not appear likely that business con- 
ditions will soon improve. 

The unprofitability of many branches of production and the 
unemployment of a sizable portion of the workers can obviously 
not be due to the slowdown in business alone. Both the unprof- 
itability and the unemployment are being intensified right now 
by the general depression. However, in this postwar period, they 
have become lasting phenomena which do not disappear entirely 
even in the upswing. We are confronted here with a new prob- 
lem, one that cannot be answered by the theory of cyclical 
changes alone. 

Let us consider, first of all, unemployment. 

A. Unemployment 

1. The Market Wage Rate Process 

Wage rates are market phenomena, just as interest rates and 
commodity prices are. Wage rates are determined by the produc- 
tivity of labor. At the wage rates toward which the market is 
tending, all those seeking work find employment and all entre- 
preneurs find the workers they are seeking. However, the 
interrelated phenomena of the market from which the “static” or 
“natural” wage rates evolve are always undergoing changes that 
generate shifts in wage rates among the various occupational 
groups. There is also always a definite time lag before those seek- 
ing work and those offering work have found one another. As a 
result, there are always sure to be a certain number of unem- 

Just as there are always houses standing empty and persons 
looking for housing on the unhampered market, just as there are 
always unsold wares in markets and persons eager to purchase 
wares they have not yet found, so there are always persons who 

The Causes of the Economic Crisis: An Address — 165 

are looking for work. However, on the unhampered market, this 
unemployment cannot attain vast proportions. Those capable of 
work will not be looking for work over a considerable period — 
many months or even years — without finding it. 

If a worker goes a long time without finding the employment 
he seeks in his former occupation, he must either reduce the 
wage rate he asks or turn to some other field where he hopes to 
obtain a higher wage than he can now get in his former occupa- 
tion. For the entrepreneur, the employment of workers is a part 
of doing business. If the wage rate drops, the profitability of his 
enterprise rises and he can employ more workers. So by reducing 
the wage rates they seek, workers are in a position to raise the 
demand for labor. 

This in no way means that the market would tend to push 
wage rates down indefinitely. Just as competition among workers 
has the tendency to lower wages, so does competition among 
employers tend to drive them up again. Market wage rates thus 
develop from the interplay of demand and supply. 

The force with which competition among employers affects 
workers may be seen very clearly by referring to the two mass 
migrations which characterized the nineteenth and early twenti- 
eth centuries. The oft-cited exodus from the land rested on the 
fact that agriculture had to release workers to industry. 
Agriculture could not pay the higher wage rates which industry 
could and which, in fact, industry had to offer in order to attract 
workers from housework, hand labor and agriculture. The migra- 
tion of workers was continually out of regions where wages were 
held down by the inferiority of general conditions of production 
and into areas where the productivity made it possible to pay 
higher wages. 

Out of every increase in productivity, the wage earner 
receives his share. For profitable enterprises seeking to expand, 
the only means available to attract more workers is to raise wage 
rates. The prodigious increase in the living standard of the 
masses, that accompanied the development of capitalism, is the 

166 — The Causes of the Economic Crisis 

result of the rise in real wages which kept abreast of the increase 
in industrial productivity. 

This self-adjusting process of the market is severely dis- 
turbed now by the interference of unions whose effectiveness 
evolved under the protection and with the assistance of govern- 
mental power. 

2. The Labor Union Wage Rate Concept 

According to labor union doctrine, wages are determined by 
the balance of power. According to this view, if the unions suc- 
ceed in intimidating the entrepreneurs, through force or threat 
of force, and holding nonunion workers off with the use of brute 
force, then wage rates can be set at whatever height desired 
without the appearance of any undesirable side effects. Thus, the 
conflict between employers and workers seems to be a struggle 
in which justice and morality are entirely on the side of the 
workers. Interest on capital and entrepreneurial profit appear to 
be ill-gotten gains. They are alleged to come from the exploita- 
tion of the worker and should be set aside for unemployment 
relief. This task, according to union doctrine, should be accom- 
plished not only by increased wage rates but also through taxes 
and welfare spending which, in a regime dominated by pro-labor 
union parties, is to be used indirectly for the benefit of the work- 

The labor unions use force to attain their goals. Only union 
members, who ask the established union wage rate and who work 
according to union-prescribed methods, are permitted to work 
in industrial undertakings. Should an employer refuse to accept 
union conditions, there are work stoppages. Workers who would 
like to work, in spite of the reproach heaped on such an under- 
taking by the union, are forced by acts of violence to give up any 
such plan. This tactic on the part of the labor unions presup- 
poses, of course, that the government at least acquiesces in their 

The Causes of the Economic Crisis: An Address — 167 

3. The Cause of Unemployment 

If the government were to proceed against those who molest 
persons willing to work and those who destroy machines and 
industrial equipment in enterprises that want to hire strikebreak- 
ers, as it normally does against the other perpetrators of violence, 
the situation would be very different. However, the characteristic 
feature of modern governments is that they have capitulated to 
the labor unions. 

The unions now have the power to raise wage rates above 
what they would be on the unhampered market. However, inter- 
ventions of this type evoke a reaction. At market wage rates, 
everyone looking for work can find work. Precisely this is the 
essence of market wages — they are established at the point at 
which demand and supply tend to coincide. If the wage rates are 
higher than this, the number of employed workers goes down. 
Unemployment then develops as a lasting phenomenon. At the 
wage rates established by the unions, a substantial portion of the 
workers cannot find any work at all. Wage increases for a portion 
of the workers are at the expense of an ever more sharply rising 
number of unemployed. 

Those without work would probably tolerate this situation for 
a limited time only. Eventually they would say: “Better a lower 
wage, than no wage at all.” Even the labor unions could not with- 
stand an assault by hundreds of thousands, or millions of 
would-be workers. The labor union policy of holding off those 
willing to work would collapse. Market wage rates would prevail 
once again. It is here that unemployment relief is brought into 
play and its role [in keeping workers from competing on the labor 
market] needs no further explanation. 

Thus, we see that unemployment, as a long-term mass phe- 
nomenon, is the consequence of the labor union policy of driving 
wage rates up. Without unemployment relief, this policy would 
have collapsed long ago. Thus, unemployment relief is not a 
means for alleviating the want caused by unemployment, as is 
assumed by misguided public opinion. It is on the contrary, one 

168 — The Causes of the Economic Crisis 

link in the chain of causes which actually makes unemployment 
a long-term mass phenomenon. 

4. The Remedy for Mass Unemployment 

Appreciation of this relationship has certainly become more 
widespread in recent years. With all due caution and with a thou- 
sand reservations, it is even generally admitted that labor union 
wage policy is responsible for the extent and duration of unem- 
ployment. All serious proposals for fighting unemployment 
depend on recognition of this theory. When proposals are made 
to reimburse entrepreneurs, directly or indirectly from public 
funds, for a part of their wage costs, if they seek to recruit the 
unemployed in their plants, then it is being recognized that 
entrepreneurs would employ more workers at a lower wage scale. 
If it is suggested that the national or municipal government 
undertake projects without considering their profitability, proj- 
ects which private enterprise does not want to carry out because 
they are not profitable, this too simply means that wage rates are 
so high that they do not permit these undertakings to make prof- 
its. (Incidentally, it may be noted that this latter proposal entirely 
overlooks the fact that a government can build and invest only if 
it withdraws the necessary means from the private economy. So 
putting this proposal into effect must lead to just as much new 
unemployment on one side as it eliminates on the other.) 

Then again, if a reduction in hours of work is considered, this 
too implies recognition of our thesis. For after all, this proposal 
seeks to shorten the working hours in such a way that all the 
unemployed will find work, and so that each individual worker, to 
the extent that he will have less work than he does today, will be 
entitled to receive less pay. Obviously this assumes that no more 
work is to be found at the present rate of pay than is currently 
being provided. The fact that wage rates are too high to give 
employment to everyone is also admitted by anyone who asks 
workers to increase production without raising wage rates. It 
goes without saying that, wherever hourly wages prevail, this 
means a reduction in the price of labor. If one assumes a cut in 
the piece rate, labor would also be cheaper where piece work 

The Causes of the Economic Crisis: An Address — 169 

prevails. Obviously then, the crucial factor is not the absolute 
height of hourly or daily wage rates, but the wage costs which 
yield a definite output. 

However, the demand to reduce wage rates is now also being 
made openly. In fact, wage rates have already been substantially 
lowered in many enterprises. Workers are called upon by the 
press and government officials to relax some of their wage 
demands and to make a sacrifice for the sake of the general wel- 
fare. To make this bearable, the prospect of price cuts is held out 
to the workers, and the governments try to secure price reduc- 
tions by putting pressure on the entrepreneurs. 

However, it is not a question of reducing wage rates. This 
bears repeating with considerable emphasis. The problem is to 
re-establish freedom in the determination of wage rates. It is true 
that in the beginning this would lead to a reduction in money 
wage rates for many groups of workers. How far this drop in wage 
rates must go to eliminate unemployment as a lasting phenome- 
non can be shown only by the free determination of wage rates 
on the labor market. Negotiations between union leaders and 
business combinations, with or without the cooperation of offi- 
cials, decisions by arbitrators or similar techniques of 
interventionism are no substitute. The determination of wage 
rates must become free once again. The formation of wage rates 
should be hampered neither by the clubs of striking pickets nor 
by government’s apparatus of force. Only if the determination of 
wage rates is free, will they be able to fulfill their function of 
bringing demand and supply into balance on the labor market. 

5. The Effects of Government Intervention 

The demand that a reduction in prices be tied in with the 
reduction in wage rates ignores the fact that wage rates appear 
too high precisely because wage reductions have not accompa- 
nied the practically universal reduction in prices. Granted, the 
prices of many articles could not join the drop in prices as they 
would on an unhampered market, either because they were pro- 
tected by special governmental interventions (tariffs, for 
instance) or because they contained substantial costs in the form 

170 — The Causes of the Economic Crisis 

of taxes and higher than unhampered market wage rates. The 
decline in the price of coal was held up in Germany because of 
the rigidity of wage rates which, in the mining of hard coal, come 
to 56 percent of the value of production. 1 The domestic price of 
iron in Germany can remain above the world market price only 
because tariff policy permits the creation of a national iron cartel 
and international agreements among national cartels. Here too, 
one need ask only that those interferences which thwart the free 
market formation of prices be abolished. There is no need to call 
for a price reduction to be dictated by government, labor unions, 
public opinion or anyone else. 

Against the assertion that unemployment is due to the extreme 
height of wages, it is entirely wrong to introduce the argument 
that wages are still higher elsewhere. If workers enjoyed complete 
freedom to move, there would be a tendency throughout the eco- 
nomic world for wage rates for similar work to be uniform. 
However, in recent years, the freedom of movement for workers 
has been considerably reduced, even almost completely abolished. 
The labor unions ask the government to forbid the migration of 
workers from abroad lest such immigrants frustrate union policy 
by underbidding the wage rates demanded by the unions. 

If there had been no immigration restrictions, millions of 
workers would have migrated from Europe to the United States 
in recent decades. This migration would have reduced the differ- 
ences between American and European wage rates. By stopping 
immigration into the United States, wage rates are raised there 
and lowered in Europe. It is not the hardheartedness of European 
capitalists, but the labor policy of the United States (and of 
Australia and other foreign countries too) which is responsible 
for the size of the gap between wage rates here in Europe and 
overseas. After all, the workers in most European countries fol- 
low the same policy of keeping out foreign competitors. They, 
too, restrict or even prohibit foreign workers from coming into 
their countries so as to protect in this way the labor union policy 
of holding up wage rates. 

1 [This address to German industrialists was given in 1931.— Ed.] 

The Causes of the Economic Crisis: An Address — 171 

6. The Process of Progress 

A popular doctrine makes “rationalization” responsible for 
unemployment. As a result of “rationalization,” practically univer- 
sal “rationalization,” it is held that those workers who cannot find 
employment anywhere become surplus. “Rationalization” is a 
modern term which has been in use for only a short time. The 
concept, however, is by no means new. The capitalistic entrepre- 
neur is continually striving to make production and marketing 
more efficient. There have been times when the course of “ration- 
alization” has been relatively more turbulent than in recent years. 
“Rationalization” was taking place on a large scale when the black- 
smith was replaced by the steel and rolling mills, handweaving 
and spinning by mechanical looms and spindles, the stagecoach 
by the steam engine — even though the word “rationalization” was 
not then known and even though there were then no officials, 
advisory boards and commissions with reports, programs and 
dogmas such as go along with the technical revolution today. 

Industrial progress has always set workers free. There have 
always been shortsighted persons who, fearing that no employ- 
ment would be found for the released workers, have tried to stop 
the progress. Workers have always resisted technical improve- 
ment and writers have always been found to justify this 
opposition. Every increase in the productivity of labor has been 
carried out in spite of the determined resistance of governments, 
“philanthropists,” “moralists” and workers. If the theory which 
attributes unemployment to “rationalization” were correct, then 
99 out of 100 workers at the end of the nineteenth century would 
have been out of work. 

Workers released by the introduction of industrial technology 
find employment in other positions. The ranks of newly develop- 
ing branches of industry are filled with these workers. The 
additional commodities available for consumption, which come 
in the wake of “rationalization,” are produced with their labor. 
Today this process is hampered by the fact that those workers 
who are released receive unemployment relief and so do not con- 
sider it necessary to change their occupation and place of work in 

172 — The Causes of the Economic Crisis 

order to find employment again. It is not on account of “rational- 
ization,” but because the unemployed are relieved of the necessity 
of looking around for new work, that unemployment has become 
a lasting phenomenon. 

B. Price Declines and Price Supports 

1. The Subsidization of Surpluses 

The opposition to market determination of prices is not lim- 
ited to wages and interest rates. Once the stand is taken not to 
permit the structure of market prices to work its effect on pro- 
duction there is no reason to stop short of commodity prices. 

If the prices of coal, sugar, coffee or rye go down, this means 
that consumers are asking more urgently for other commodities. 
As a result of the decline in such prices, some concerns produc- 
ing these commodities become unprofitable and are forced to 
reduce production or shut down completely. The capital and 
labor thus released are then shifted to other branches of the 
economy in order to produce commodities for which a stronger 
demand prevails. 

However, politics interferes once again. It tries to hinder the 
adjustment of production to the requirements of consumption — by 
coming to the aid of the producer who is hurt by price reductions. 

In recent years, capitalistic methods of production have been 
applied more and more extensively to the production of raw 
materials. As always, wherever capitalism prevails, the result has 
been an astonishing increase in productivity. Grain, fruit, meat, 
rubber, wool, cotton, oil, copper, coal, minerals are all much more 
readily available now than they were before the war and in the 
early postwar years. Yet, it was just a short while ago that govern- 
ments believed they had to devise ways and means to ease the 
shortage of raw materials. When, without any help from them, 
the years of plenty came, they immediately took up the cudgels to 
prevent this wealth from having its full effect for economic well- 
being. The Brazilian government wants to prevent the decline in 

The Causes of the Economic Crisis: An Address — 173 

the price of coffee so as to protect plantation owners who oper- 
ate on poorer soil or with less capital from having to cut down or 
give up cultivation. The much richer United States government 
wants to stop the decline in the price of wheat and in many other 
prices because it wants to relieve the farmer working on poorer 
soil of the need to adjust or discontinue his enterprise. 

Tremendous sums are sacrificed throughout the world in 
completely hopeless attempts to forestall the effects of the 
improvements made under capitalistic production. Billions are 
spent in the fruitless effort to maintain prices and in direct sub- 
sidy to those producers who are less capable of competing. 
Further billions are indirectly used for the same goals, through 
protective tariffs and similar measures which force consumers to 
pay higher prices. The aim of all these interventions — which 
drive prices up so high as to keep in business producers who 
would otherwise be unable to meet competition — can certainly 
never be attained. However, all these measures delay the process- 
ing industries, which use capital and labor, in adjusting their 
resources to the new supplies of raw materials produced. Thus 
the increase in commodities represents primarily an embarrass- 
ment and not an improvement in living standards. Instead of 
becoming a blessing for the consumer, the wealth becomes a bur- 
den for him, if he must pay for the government interventions in 
the form of higher taxes and tariffs. 

2. The Need for Readjustments 

The cultivation of wheat in central Europe was jeopardized by 
the increase in overseas production. Even if European farmers 
were more efficient, more skilled in modern methods and better 
supplied with capital, even if the prevailing industrial arrangement 
were not small and pygmy-sized, wasteful, productivity-hamper- 
ing enterprises, these farms on less fertile soil with less favorable 
weather conditions, still could not rival the wheat farms of Canada. 
Central Europe must reduce its cultivation of grain, as it cut down 
on the breeding of sheep decades ago. The billions which the hope- 
less struggle against the better soil of America has already cost is 

174 — The Causes of the Economic Crisis 

money uselessly squandered. The future of central European agri- 
culture does not lie in the cultivation of grain. Denmark and 
Holland have shown that agriculture can exist in Europe even 
without the protection of tariffs, subsidies and special privileges. 
However, the economy of central Europe will depend in the future, 
to a still greater extent than before, on industry. 

By this time, it is easy to understand the paradox of the phe- 
nomenon that higher yields in the production of raw materials and 
foodstuffs cause harm. The interventions of governments and of 
the privileged groups, which seek to hinder the adjustment of the 
market to the situation brought about by new circumstances, 
mean that an abundant harvest brings misfortune to everyone. 

In recent decades, in almost all countries of the world, attempts 
have been made to use high protective tariffs to develop economic 
self-sufficiency (autarky) among smaller and middle-sized 
domains. Tremendous sums have been invested in manufacturing 
plants for which there was no economic demand. The result is that 
we are rich today in physical structures, the facilities of which can- 
not be fully exploited or perhaps not even used at all. 

The result of all these efforts to annul the laws which the mar- 
ket decrees for the capitalistic economy is, briefly, lasting 
unemployment of many millions, unprofitability for industry and 
agriculture, and idle factories. As a result of all these, political 
controversies become seriously aggravated, not only within 
countries but also among nations. 

C. Tax Policy 

1. The Anti-Capitalistic Mentality 

The harmful influence of politics on the economy goes 
far beyond the consequences of the interventionist measures 
previously discussed. 

There is no need to mention the mobilization policies of the 
government, the continual controversies constantly emerging 
from nationalistic conflicts in multi-lingual communities and the 

The Causes of the Economic Crisis: An Address — 175 

anxiety caused by saber rattling ministers and political parties. 
All of these things create unrest. Thus, they may indirectly aggra- 
vate the crisis situation and especially the uneasiness of the 
business world. 

Financial policy, however, works directly. 

The share of the people’s income which government exacts for 
its expenditures, even entirely apart from military spending, is 
continually rising. There is hardly a single country in Europe in 
which tremendous sums are not being wasted on largely mis- 
guided national and municipal economic undertakings. 
Everywhere, we see government continually taking over new 
tasks when it is hardly able to carry out satisfactorily its previous 
obligations. Everywhere, we see the bureaucracy swell in size. As 
a result, taxes are rising everywhere. At a time when the need to 
reduce production costs is being universally discussed, new taxes 
are being imposed on production. Thus the economic crisis is, at 
the same time, a crisis in public finance also. This crisis in public 
finance will not be resolved without a complete revision of gov- 
ernment operations. 

One widely held view, which easily dominates public opinion 
today, maintains that taxes on wealth are harmless. Thus every 
governmental expenditure is justified, if the funds to pay for it are 
not raised by taxing mass consumption or imposing income taxes 
on the masses. This idea, which must be held responsible for the 
mania toward extravagance in government expenditures, has 
caused those in charge of government financial policy to lose 
completely any feeling of a need for economy. Spending a large 
part of the people’s income in senseless ways — in order to carry 
out futile price support operations, to undertake the hopeless 
task of trying to support with subsidies unprofitable enterprises 
which could not otherwise survive, to cover the losses of unprof- 
itable public enterprises and to finance the unemployment of 
millions — would not be justified, even if the funds for the pur- 
pose were collected in ways that do not aggravate the crisis. 
However, tax policy is aimed primarily, or even exclusively, at 
taxing the yield on capital and the capital itself. This leads to a 
slowing down of capital formation and even, in many countries, 

176 — The Causes of the Economic Crisis 

to capital consumption. However, this concerns not capitalists 
only, as generally assumed. The quantitatively lower the ratio of 
capital to workers, the lower the wage rates which develop on the 
free labor market. Thus, even workers are affected by this policy. 

Because of tax legislation, entrepreneurs must frequently oper- 
ate their businesses differently from the way reason would 
otherwise indicate. As a result, productivity declines and conse- 
quently so does the provision of goods for consumption. As might 
be expected, capitalists shy away from leaving capital in countries 
with the highest taxation and turn to lands where taxes are lower. 
It becomes more difficult, on that account, for the system of pro- 
duction to adjust to the changing pattern of economic demand. 

Financial policy certainly did not create the crisis. However, it 
does contribute substantially to making it worse. 

D. Gold Production 
1. The Decline in Prices 

One popular doctrine blames the crisis on the insufficiency of 
gold production. 

The basic error in this attempt to explain the crisis rests on 
equating a drop in prices with a crisis. A slow, steady, downward 
slide in the prices of all goods and services could be explained by 
the relationship to the production of gold. Businessmen have 
become accustomed to a relationship of the demand for, and sup- 
ply of, gold from which a slow steady rise in prices emerges as a 
secular (continuing) trend. However, they could just as easily 
have become reconciled to some other arrangement — and they 
certainly would have if developments had made that necessary. 
After all, the businessman’s most important characteristic is flex- 
ibility. The businessman can operate at a profit, even if the 
general tendency of prices is downward, and economic condi- 
tions can even improve then too. 

The turbulent price declines since 1929 were definitely not gen- 
erated by the gold production situation. Moreover, gold 

The Causes of the Economic Crisis: An Address — 177 

production has nothing to do with the fact that the decline in 
prices is not universal, nor that it does not specifically involve 
wages also. 

It is true that there is a close connection between the quantity 
of gold produced and the formation of prices. Fortunately, this is 
no longer in dispute. If gold production had been considerably 
greater than it actually was in recent years, then the drop in 
prices would have been moderated or perhaps even prevented 
from appearing. It would be wrong, however, to assume that the 
phenomenon of the crisis would not then have occurred. The 
attempts of labor unions to drive wages up higher than they 
would have been on the unhampered market and the efforts of 
governments to alleviate the difficulties of various groups of pro- 
ducers have nothing to do with whether actual money prices are 
higher or lower. 

Labor unions no longer contend over the height of money 
wages, but over the height of real wages. It is not because of low 
prices that producers of rye, wheat, coffee and so on are impelled 
to ask for government interventions. It is because of the unprof- 
itability of their enterprises. However, the profitability of these 
enterprises would be no greater, even if prices were higher. For if 
the gold supply had been increased, not only would the prices of 
the products which the enterprises in question produce and want 
to sell have become or have remained proportionately higher, but 
so also would the prices of all the goods which comprise their 
costs. Then too, as in any inflation, an increase in the gold supply 
does not affect all prices at the same time, nor to the same extent. 
It helps some groups in the economy and hurts others. Thus no 
reason remains for assuming that an increase in the gold supply 
must, in a particular case, improve the situation for precisely 
those producers who now have cause to complain about the 
unprofitability of their undertakings. It could be that their situa- 
tion would not only not be improved; it might even be worsened. 

The error in equating the drop in prices with the crisis and, 
thus, considering the cause of this crisis to be the insufficient 
production of gold is especially dangerous. It leads to the view 
that the crisis could be overcome by increasing the fiduciary 

178 — The Causes of the Economic Crisis 

media in circulation. Thus the banks are asked to stimulate busi- 
ness conditions with the issue of additional banknotes and an 
additional credit expansion through credit entries. At first, to be 
sure, a boom can be generated in this way. However, as we have 
seen, such an upswing must eventually lead to a collapse in the 
business outlook and a new crisis. 

2. Inflation as a “Remedy” 

It is astonishing that sincere persons can either make such a 
demand or lend it support. Every possible argument in favor of 
such a scheme has already been raised a hundred times, and 
demolished a thousand times over. Only one argument is new, 
although on that account no less false. This is to the effect that 
the higher than unhampered market wage rates can be brought 
into proper relationship most easily by an inflation. 

This argument shows how seriously concerned our political 
economists are to avoid displeasing the labor unions. Although 
they cannot help but recognize that wage rates are too high and 
must be reduced, they dare not openly call for a halt to such over- 
payments. Instead, they propose to outsmart the unions in some 
way. They propose that the actual money wage rate remain 
unchanged in the coming inflation. In effect, this would amount 
to reducing the real wage. This assumes, of course, that the 
unions will refrain from making further wage demands in the 
ensuing boom and that they will, instead, remain passive while 
their real wage rates deteriorate. Even if this entirely unjustified 
optimistic expectation is accepted as true, nothing is gained 
thereby. A boom caused by banking policy measures must still 
lead eventually to a crisis and a depression. So, by this method, 
the problem of lowering wage rates is not resolved but simply 

Yet, all things considered, many may think it advantageous to 
delay the unavoidable showdown with labor union policy. 
However, this ignores the fact that, with each artificial boom, 
large sums of capital are malinvested and, as a result, wasted. 
Every diminution in society’s stock of capital must lead toward a 
reduction in the “natural” or “static” wage rate. Thus, postponing 

The Causes of the Economic Crisis: An Address — 179 

the decision costs the masses a great deal. Moreover, it will make 
the final confrontation still more difficult, rather than easier. 


Is There a Way Out? 

1. The Cause of Our Difficulties 

The severe convulsions of the economy are the inevitable result 
of policies which hamper market activity, the regulator of capital- 
istic production. If everything possible is done to prevent the 
market from fulfilling its function of bringing supply and demand 
into balance, it should come as no surprise that a serious dispro- 
portionality between supply and demand persists, that 
commodities remain unsold, factories stand idle, many millions 
are unemployed, destitution and misery are growing and that 
finally, in the wake of all these, destructive radicalism is rampant 
in politics. 

The periodically returning crises of cyclical changes in busi- 
ness conditions are the effect of attempts, undertaken repeatedly, 
to underbid the interest rates which develop on the unhampered 
market. These attempts to underbid unhampered market interest 
rates are made through the intervention of banking policy — by 
credit expansion through the additional creation of uncovered 
notes and checking deposits — in order to bring about a boom. 
The crisis under which we are now suffering is of this type, too. 
However, it goes beyond the typical business cycle depression, 
not only in scale but also in character — because the interventions 
with market processes which evoked the crisis were not limited 
only to influencing the rate of interest. The interventions have 
directly affected wage rates and commodity prices, too. 

With the economic crisis, the breakdown of interventionist 
economic policy — the policy being followed today by all govern- 
ments, irrespective of whether they are responsible to 

180 — The Causes of the Economic Crisis 

parliaments or rule openly as dictatorships — becomes apparent. 
This catastrophe obviously comes as no surprise. Economic the- 
ory has long been predicting such an outcome to interventionism. 

The capitalistic economic system, that is the social system 
based on private ownership of the means of production, is 
rejected unanimously today by all political parties and govern- 
ments. No similar agreement may be found with respect to what 
economic system should replace it in the future. Many, although 
not all, look to socialism as the goal. They stubbornly reject the 
result of the scientific examination of the socialistic ideology, 
which has demonstrated the unworkability of socialism. They 
refuse to learn anything from the experiences of the Russian and 
other European experiments with socialism. 

2. The Unwanted Solution 

Concerning the task of present economic policy, however, 
complete agreement prevails. The goal is an economic arrange- 
ment which is assumed to represent a compromise solution, the 
“middle-of-the-road” between socialism and capitalism. To be 
sure, there is no intent to abolish private ownership of the means 
of production. Private property will be permitted to continue, 
although directed, regulated and controlled by government and 
by other agents of society’s coercive apparatus. With respect to 
this system of interventionism, the science of economics points 
out, with incontrovertible logic, that it is contrary to reason, that 
the interventions, which go to make up the system, can never 
accomplish the goals their advocates hope to attain, and that 
every intervention will have consequences no one wanted. 

The capitalistic social order acquires meaning and purpose 
through the market. Hampering the functions of the market and 
the formation of prices does not create order. Instead it leads to 
chaos, to economic crisis. 

All attempts to emerge from the crisis by new interventionist 
measures are completely misguided. There is only one way out of 
the crisis: Forgo every attempt to prevent the impact of market 
prices on production. Give up the pursuit of policies which seek 

The Causes of the Economic Crisis: An Address 181 

to establish interest rates, wage rates and commodity prices dif- 
ferent from those the market indicates. This may contradict the 
prevailing view. It certainly is not popular. Today all govern- 
ments and political parties have full confidence in 
interventionism and it is not likely that they will abandon their 
program. However, it is perhaps not too optimistic to assume 
that those governments and parties whose policies have led to 
this crisis will some day disappear from the stage and make way 
for men whose economic program leads, not to destruction and 
chaos, but to economic development and progress. 


The Current Status of Business Cycle 
Research and Its Prospects for the 
Immediate Future (193 3) 

I. The Acceptance of the Circulation 
Credit Theory of Business Cycles 

I t is frequently claimed that if the causes of cyclical changes 
were understood, economic programs suitable for smoothing 
out cyclical “waves” would be adopted. The upswing would 
then be throttled down in time to soften the decline that 
inevitably follows in its wake. As a result, economic development 
would proceed at a more even pace. The boom’s accompanying 
side effects, considered by many to be undesirable, would then be 
substantially, perhaps entirely, eliminated. Most significantly, 
however, the losses inflicted by the crisis and by the decline, 
which almost everyone deplores, would be considerably reduced, 
or even completely avoided. 

For many people, this prospect has little appeal. In their opin- 
ion, the disadvantages of the depression are not too high a price to 
pay for the prosperity of the upswing. They say that not everything 

[Mises’s contribution to a Festschrift for Arthur Spiethoff, Die Stellung und 
der nachste Zukunft der Konjunkturforschung, pp. 175-80 (Munich: 
Duncker and Humblot, 1933). All the contributors were asked to address 
themselves to the same topic. Another translation of this article, by Joseph 
R. Stromberg, then a doctoral candidate in history at the University of 
Florida, appeared in The Libertarian Forum (June 1975). This is a com- 
pletely different translation, made by Bettina Bien Greaves and edited by 
Percy L. Greaves.— Ed.] 


184 — The Causes of the Economic Crisis 

produced during the boom period is malinvestment, which must 
be liquidated by the crisis. In their opinion, some of the fruits of the 
boom remain and the progressing economy cannot do without 
them. However, most economists have looked on the elimination 
of cyclical changes as both desirable and necessary. Some came to 
this position because they thought that, if the economy were 
spared the shock of recurring crises every few years, it would help 
to preserve the capitalistic system of which they approved. Others 
have welcomed the prospect of an age without crises precisely 
because they saw — in an economy that was not disturbed by busi- 
ness fluctuations — no difficulties in the elimination of the 
entrepreneurs who, in their view, were merely the superfluous 
beneficiaries of the efforts of others. 

Whether these authors looked on the prospect of smoothing 
out cyclical waves as favorable or unfavorable, all were of the 
opinion that a more thorough examination of the cause of peri- 
odic economic changes would help produce an age of less severe 
fluctuations. Were they right? 

Economic theory cannot answer this question — it is not a the- 
oretical problem. It is a problem of economic policy or, more 
precisely, of economic history. Although their measures may pro- 
duce badly muddled results, the persons responsible for directing 
the course of economic policy are better informed today concern- 
ing the consequences of an expansion of circulation credit than 
were their earlier counterparts, especially those on the European 
continent. Yet, the question remains. Will measures be introduced 
again in the future which must lead via a boom to a bust? 

The Circulation Credit (Monetary) Theory of the Trade Cycle 
must be considered the currently prevailing doctrine of cyclical 
change. Even persons, who hold another theory, find it necessary 
to make concessions to the Circulation Credit Theory. Every sug- 
gestion made for counteracting the present economic crisis uses 
reasoning developed by the Circulation Credit Theory. Some 
insist on rescuing every price from momentary distress, even if 
such distress comes in the upswing following a new crisis. To do 
this, they would “prime the pump” by further expanding the 
quantity of fiduciary media. Others oppose such artificial 

The Current Status of Business Cycle Research — 185 

stimulation, because they want to avoid the illusory credit expan- 
sion induced prosperity and the crisis that will inevitably follow. 

However, even those who advocate programs to spark and 
stimulate a boom recognize, if they are not completely hopeless 
dilettantes and ignoramuses, the conclusiveness of the 
Circulation Credit Theory’s reasoning. They do not contest the 
truth of the Circulation Credit Theory’s objections to their posi- 
tion. Instead, they try to ward them off by pointing out that they 
propose only a “moderate,” a carefully prescribed “dosage” of 
credit expansion or “monetary creation” which, they say, would 
merely soften, or bring to a halt, the further decline of prices. 
Even the term “re-deflation ,” 1 newly introduced in this connec- 
tion with such enthusiasm, implies recognition of the Circulation 
Credit Theory. However, there are also fallacies implied in the 
use of this term. 

II. The Popularity of Low Interest Rates 

The credit expansion which evokes the upswing always origi- 
nates from the idea that business stagnation must be overcome by 
“easy money.” Attempts to demonstrate that this is not the case 
have been in vain. If anyone argues that lower interest rates have 
not been constantly portrayed as the ideal goal for economic pol- 
icy, it can only be due to lack of knowledge concerning economic 
history and recent economic literature. Practically no one has 
dared to maintain that it would be desirable to have higher inter- 
est rates sooner . 2 People, who sought cheap credit, clamored for 
the establishment of credit-issuing banks and for these banks to 

1 [The more modern term for what Mises apparently meant by “re-defla- 
tion” is undoubtedly “reflation.”— Ed.] 

2 That has always been so; public opinion has always sided with the 
debtors. (See Jeremy Bentham, Defence of Usury, 2nd ed. [London, 1790], 
pp. 102ff.). The idea that the creditors are the idle rich, hardhearted 
exploiters of workers, and that the debtors are the unfortunate poor, has 
not been abandoned even in this age of bonds, bank deposits and savings 

186 — The Causes of the Economic Crisis 

reduce interest rates. Every measure seized upon to avoid “raising 
the discount rate” has had its roots in the concept that credit must 
be made “easy.” The fact that reducing interest rates through 
credit expansion must lead to price increases has generally been 
ignored. However, the cheap money policy would not have been 
abandoned even if this had been recognized. 

Public opinion is not committed to one single view with 
respect to the height of prices as it is in the case of interest rates. 
Concerning prices, there have always been two different views: 
On the one side, the demand of producers for higher prices and, 
on the other side, the demand of consumers for lower prices. 
Governments and political parties have championed both 
demands, if not at the same time, then shifting from time to time 
according to the groups of voters whose favors they court at the 
moment. First one slogan, then another is inscribed on their ban- 
ners, depending on the temporary shift of prices desired. If prices 
are going up, they crusade against the rising cost of living. If 
prices are falling, they profess their desire to do everything pos- 
sible to assure “reasonable” prices for producers. Still, when it 
comes to trying to reduce prices, they generally sponsor pro- 
grams which cannot attain that goal. No one wants to adopt the 
only effective means — the limitation of circulation credit — 
because they do not want to drive interest rates up . 3 In times of 
declining prices, however, they have been more than ready to 
adopt credit expansion measures, as this goal is attainable by the 
means already desired, i.e., by reducing interest rates. 

Today, those who would seek to expand circulation credit 
counter objections by explaining that they only want to adjust for 
the decline in prices that has already taken place in recent years, 
or at least to prevent a further decline in prices. Thus, it is 
claimed, such expansion introduces nothing new. Similar argu- 
ments were also heard [during the nineteenth century] at the 
time of the drive for bimetallism. 

3 An extreme example: the discount policy of the German Reichsbank in 
the time of inflation. See Frank Graham, Exchange, Prices and Production in 
Hyper-Inflation Germany, 1920-1923 (Princeton, N.J., 1930), pp. 65ff. 

The Current Status of Business Cycle Research — 187 

III. The Popularity of Labor Union Policy 

It is generally recognized that the social consequences of 
changes in the value of money — apart from the effect such 
changes have on the value of monetary obligations — may be 
attributed solely to the fact that these changes are not effected 
equally and simultaneously with respect to all goods and serv- 
ices. That is, not all prices rise to the same extent and at the same 
time. Hardly anyone disputes this today. Moreover, it is no longer 
denied, as it generally was a few years ago, that the duration of 
the present crisis is caused primarily by the fact that wage rates 
and certain prices have become inflexible, as a result of union 
wage policy and various price support activities. Thus, the rigid 
wage rates and prices do not fully participate in the downward 
movement of most prices, or do so only after a protracted delay. 
In spite of all contradictory political interventions, it is also 
admitted that the continuing mass unemployment is a necessary 
consequence of the attempts to maintain wage rates above those 
that would prevail on the unhampered market. However, in 
forming economic policy, the correct inference from this is not 

Almost all who propose priming the pump through credit 
expansion consider it self-evident that money wage rates will not 
follow the upward movement of prices until their relative excess 
[over the earlier market prices] has disappeared. Inflationary 
projects of all kinds are agreed to because no one openly dares to 
attack the union wage policy, which is approved by public opin- 
ion and promoted by government. Therefore, so long as today’s 
prevailing view, concerning the maintenance of higher than 
unhampered market wage rates and the interventionist measures 
supporting them, exists, there is no reason to assume that money 
wage rates can be held steady in a period of rising prices. 

IV. The Effect of Lower than Unhampered 

Market Interest Rates 

The causal connection [between credit expansion and rising 
prices] is denied still more intensely if the proposal for limiting 

188 — The Causes of the Economic Crisis 

credit expansion is tied in with certain anticipations. If the entre- 
preneurs expect low interest rates to continue, they will use the 
low interest rates as a basis for their computations. Only then will 
entrepreneurs allow themselves to be tempted, by the offer of 
more ample and cheaper credit, to consider business enterprises 
which would not appear profitable at the higher interest rates 
that would prevail on the unaltered loan market. 

If it is publicly proclaimed that care will be taken to stop the 
creation of additional credit in time, then the hoped-for gains 
must fail to appear. No entrepreneur will want to embark on a 
new business if it is clear to him in advance that the business can- 
not be carried through to completion successfully. The failure of 
recent pump-priming attempts and statements of the authorities 
responsible for banking policy make it evident that the time of 
cheap money will very soon come to an end. If there is talk of 
restriction in the future, one cannot continue to “prime the 
pump” with credit expansion. 

Economists have long known that every expansion of credit 
must someday come to an end and that, when the creation of 
additional credit stops, this stoppage must cause a sudden change 
in business conditions. A glance at the daily and weekly press in 
the “boom” years since the middle of the last century shows that 
this understanding was by no means limited to a few persons. Still 
the speculators, averse to theory as such, did not know it, and they 
continued to engage in new enterprises. However, if the govern- 
ments were to let it be known that the credit expansion would 
continue only a little longer, then its intention to stop expanding 
would not be concealed from anyone. 

V. The Questionable Fear of Declining Prices 

People today are inclined to overvalue the significance of 
recent accomplishments in clarifying the business cycle problem 
and to undervalue the Currency School’s tremendous contribu- 
tion. The benefit which practical cyclical policy could derive 
from the old Currency School theoreticians has still not been 
fully exploited. Modern cyclical theory has contributed little to 

The Current Status of Business Cycle Research — 189 

practical policy that could not have been learned from the 
Currency Theory. 

Unfortunately, economic theory is weakest precisely where 
help is most needed — in analyzing the effects of declining prices. 
A general decline in prices has always been considered unfortu- 
nate. Yet today, even more than ever before, the rigidity of wage 
rates and the costs of many other factors of production hamper 
an unbiased consideration of the problem. Therefore, it would 
certainly be timely now to investigate thoroughly the effects of 
declining money prices and to analyze the widely held idea that 
declining prices are incompatible with the increased production 
of goods and services and an improvement in general welfare. 
The investigation should include a discussion of whether it is true 
that only inflationistic steps permit the progressive accumulation 
of capital and productive facilities. So long as this naive inflation- 
ist theory of development is firmly held, proposals for using 
credit expansion to produce a boom will continue to be success- 

The Currency Theory described some time ago the necessary 
connection between credit expansion and the cycle of economic 
changes. Its chain of reasoning was only concerned with a credit 
expansion limited to one nation. It did not do justice to the situ- 
ation, of special importance in our age of attempted cooperation 
among the banks of issue, in which all countries expanded 
equally. In spite of the Currency Theory’s explanation, the banks 
of issue have persistently advised further expansion of credit. 

This strong drive on the part of the banks of issue may be 
traced back to the prevailing idea that rising prices are useful and 
absolutely necessary for “progress” and to the belief that credit 
expansion was a suitable method for keeping interest rates low. 
The relationship between the issue of fiduciary media and the 
formation of interest rates is sufficiently explained today, at least 
for the immediate requirements of determining economic policy. 
However, what still remains to be explained satisfactorily is the 
problem of generally declining prices. 


The Trade Cycle and Credit 
Expansion: The Economic 
Consequences of Cheap 
Money (1946) 

T he author of this paper is fully aware of its insufficiency. 
Yet, there is no means of dealing with the problem of the 
trade cycle in a more satisfactory way if one does not 
write a treatise embracing all aspects of the capitalist market 
economy. The author fully agrees with the dictum of Bohm- 
Bawerk: “A theory of the trade cycle, if it is not to be mere 
botching, can only be written as the last chapter or the last chap- 
ter but one of a treatise dealing with all economic problems.” 

It is only with these reservations that the present writer pres- 
ents this rough sketch to the members of the Committee. 

I. The Unpopularity of Interest 

One of the characteristic features of this age of wars and 
destruction is the general attack launched by all governments and 
pressure groups against the rights of creditors. The first act of the 
Bolshevik Government was to abolish loans and payment of 
interest altogether. The most popular of the slogans that swept 
the Nazis into power was Brechung der Zinsknechtschaft, abolition 
of interest-slavery. The debtor countries are intent upon expro- 
priating the claims of foreign creditors by various devices, the 
most efficient of which is foreign exchange control. Their eco- 
nomic nationalism aims at brushing away an alleged return to 

[From a memorandum, dated April 24, 1946, prepared in English by 
Professor Mises for a committee of businessmen for whom he served as a 
consultant.— Ed.] 


192 — The Causes of the Economic Crisis 

colonialism. They pretend to wage a new war of independence 
against the foreign exploiters as they venture to call those who 
provided them with the capital required for the improvement of 
their economic conditions. As the foremost creditor nation today 
is the United States, this struggle is virtually directed against the 
American people. Only the old usages of diplomatic reticence 
make it advisable for the economic nationalists to name the devil 
they are fighting not the Yankees, but “Wall Street.” 

“Wall Street” is no less the target at which the monetary 
authorities of this country are directing their blows when 
embarking upon an “easy money” policy. It is generally assumed 
that measures designed to lower the rate of interest, below the 
height at which the unhampered market would fix it, are 
extremely beneficial to the immense majority at the expense of a 
small minority of capitalists and hardboiled moneylenders. It is 
tacitly implied that the creditors are the idle rich while the 
debtors are the industrious poor, However, this belief is atavistic 
and utterly misjudges contemporary conditions. 

In the days of Solon, Athens’s wise legislator, in the time of 
ancient Rome’s agrarian laws, in the Middle Ages and even for 
some centuries later, one was by and large right in identifying the 
creditors with the rich and the debtors with the poor. It is quite 
different in our age of bonds and debentures, of savings banks, of 
life insurance and social security. The proprietary classes are the 
owners of big plants and farms, of common stock, of urban real 
estate and, as such, they are very often debtors. The people of 
more modest income are bondholders, owners of saving deposits 
and insurance policies and beneficiaries of social security. As 
such, they are creditors. Their interests are impaired by endeav- 
ors to lower the rate of interest and the national currency’s 
purchasing power. 

It is true that the masses do not think of themselves as credi- 
tors and thus sympathize with the noncreditor policies. However, 
this ignorance does not alter the fact that the immense majority 
of the nation are to be classified as creditors and that these peo- 
ple, in approving of an “easy money” policy, unwittingly hurt 
their own material interests. It merely explodes the Marxian fable 

The Trade Cycle and Credit Expansion — 193 

that a social class never errs in recognizing its particular class 
interests and always acts in accordance with these interests. 

The modern champions of the “easy money” policy take pride 
in calling themselves unorthodox and slander their adversaries as 
orthodox, old-fashioned and reactionary. One of the most elo- 
quent spokesmen of what is called functional finance, Professor 
Abba Lerner, pretends that in judging fiscal measures he and his 
friends resort to what “is known as the method of science as 
opposed to scholasticism.” The truth is that Lord Keynes, 
Professor Alvin H. Hansen and Professor Lerner, in their passion- 
ate denunciation of interest, are guided by the essence of 
Medieval Scholasticism’s economic doctrine, the disapprobation 
of interest. While emphatically asserting that a return to the 
nineteenth century’s economic policies is out of the question, 
they are zealously advocating a revival of the methods of the Dark 
Ages and of the orthodoxy of old canons. 

II. The Two Classes of Credit 

There is no difference between the ultimate objectives of the 
anti-interest policies of canon law and the policies recommended 
by modern interest-baiting. But the methods applied are differ- 
ent. Medieval orthodoxy was intent first upon prohibiting by 
decree interest altogether and later upon limiting the height of 
interest rates by the so-called usury laws. Modern self-styled 
unorthodoxy aims at lowering or even abolishing interest by 
means of credit expansion. 

Every serious discussion of the problem of credit expansion 
must start from the distinction between two classes of credit: 
commodity credit and circulation credit. 

Commodity credit is the transfer of savings from the hands of 
the original saver into those of the entrepreneurs who plan to use 
these funds in production. The original saver has saved money by 
not consuming what he could have consumed by spending it for 
consumption. He transfers purchasing power to the debtor and 
thus enables the latter to buy these nonconsumed commodities 
for use in further production. Thus the amount of commodity 
credit is strictly limited by the amount of saving, i.e., abstention 

194 — The Causes of the Economic Crisis 

from consumption. Additional credit can only be granted to the 
extent that additional savings have been accumulated. The whole 
process does not affect the purchasing power of the monetary 

Circulation credit is credit granted out of funds especially cre- 
ated for this purpose by the banks. In order to grant a loan, the 
bank prints banknotes or credits the debtor on a deposit account. 
It is creation of credit out of nothing. It is tantamount to the cre- 
ation of fiat money, to undisguised, manifest inflation. It 
increases the amount of money substitutes, of things which are 
taken and spent by the public in the same way in which they deal 
with money proper. It increases the buying power of the debtors. 
The debtors enter the market of factors of production with an 
additional demand, which would not have existed except for the 
creation of such banknotes and deposits. This additional demand 
brings about a general tendency toward a rise in commodity 
prices and wage rates. 

While the quantity of commodity credit is rigidly fixed by the 
amount of capital accumulated by previous saving, the quantity 
of circulation credit depends on the conduct of the bank’s busi- 
ness. Commodity credit cannot be expanded, but circulation 
credit can. Where there is no circulation credit, a bank can only 
increase its lending to the extent that the savers have entrusted it 
with more deposits. Where there is circulation credit, a bank can 
expand its lending by what is, curiously enough, called “being 
more liberal.” 

Credit expansion not only brings about an inextricable ten- 
dency for commodity prices and wage rates to rise it also affects 
the market rate of interest. As it represents an additional quan- 
tity of money offered for loans, it generates a tendency for 
interest rates to drop below the height they would have reached 
on a loan market not manipulated by credit expansion. It owes its 
popularity with quacks and cranks not only to the inflationary 
rise in prices and wage rates which it engenders, but no less to its 
short-run effect of lowering interest rates. It is today the main 
tool of policies aiming at cheap or easy money. 

The Trade Cycle and Credit Expansion — 195 

III. The Function of Prices, Wage Rates, 
and Interest Rates 

The rate of interest is a market phenomenon. In the market 
economy it is the structure of prices, wage rates and interest 
rates, as determined by the market, that directs the activities of 
the entrepreneurs toward those lines in which they satisfy the 
wants of the consumers in the best possible and cheapest way. 
The prices of the material factors of production, wage rates and 
interest rates on the one hand and the anticipated future prices of 
the consumers’ goods on the other hand are the items that enter 
into the planning businessman’s calculations. The result of these 
calculations shows the businessman whether or not a definite 
project will pay. If the market data underlying his calculations are 
falsified by the interference of the government, the result must be 
misleading. Deluded by an arithmetical operation with illusory 
figures, the entrepreneurs embark upon the realization of proj- 
ects that are at variance with the most urgent desires of 
consumers. The disagreement of the consumers becomes mani- 
fest when the products of capital malinvestment reach the 
market and cannot be sold at satisfactory prices. Then, there 
appears what is called “bad business.” 

If, on a market not hampered by government tampering with 
the market data, the examination of a definite project shows its 
unprofitability, it is proved that under the given state of affairs the 
consumers prefer the execution of other projects. The fact that a 
definite business venture is not profitable means that the con- 
sumers, in buying its products, are not ready to reimburse 
entrepreneurs for the prices of the complementary factors of pro- 
duction required, while on the other hand, in buying other 
products, they are ready to reimburse entrepreneurs for the prices 
of the same factors. Thus the sovereign consumers express their 
wishes and force business to adjust its activities to the satisfaction 
of those wants which they consider the most urgent. The con- 
sumers thus bring about a tendency for profitable industries to 
expand and for unprofitable ones to shrink. 

196 — The Causes of the Economic Crisis 

It is permissible to say that what proximately prevents the exe- 
cution of certain projects is the state of prices, wage rates and 
interest rates. It is a serious blunder to believe that if only these 
items were lower, production activities could be expanded. What 
limits the size of production is the scarcity of the factors of pro- 
duction. Prices, wage rates and interest rates are only indices 
expressive of the degree of this scarcity. They are pointers, as it 
were. Through these market phenomena, society sends out a 
warning to the entrepreneurs planning a definite project: Don’t 
touch this factor of production; it is earmarked for the satisfac- 
tion of another, more urgent need. 

The expansionists, as the champions of inflation style them- 
selves today, see in the rate of interest nothing but an obstacle to 
the expansion of production. If they were consistent, they would 
have to look in the same way at the prices of the material factors of 
production and at wage rates. A government decree cutting down 
wage rates to 50 percent of those on the unhampered labor market 
would likewise give to certain projects, which do not appear prof- 
itable in a calculation based on the actual market data, the 
appearance of profitability. There is no more sense in the assertion 
that the height of interest rates prevents a further expansion of 
production than in the assertion that the height of wage rates 
brings about these effects. The fact that the expansionists apply 
this kind of fallacious argumentation only to interest rates and not 
also to the prices of primary commodities and to the prices of labor 
is the proof that they are guided by emotions and passions and not 
by cool reasoning. They are driven by resentment. They envy what 
they believe is the rich man’s take. They are unaware of the fact that 
in attacking interest they are attacking the broad masses of savers, 
bondholders and beneficiaries of insurance policies. 

IV. The Effects of Pofiticaffy Lowered Interest Rates 

The expansionists are quite right in asserting that credit 
expansion succeeds in bringing about booming business. They 
are mistaken only in ignoring the fact that such an artificial 
prosperity cannot last and must inextricably lead to a slump, a 
general depression. 

The Trade Cycle and Credit Expansion — 197 

If the market rate of interest is reduced by credit expansion, 
many projects which were previously deemed unprofitable get 
the appearance of profitability. The entrepreneur who embarks 
upon their execution must, however, very soon discover that his 
calculation was based on erroneous assumptions. He has reck- 
oned with those prices of the factors of production which 
corresponded to market conditions as they were on the eve of the 
credit expansion. But now, as a result of credit expansion, these 
prices have risen. The project no longer appears so promising as 
before. The businessman’s funds are not sufficient for the pur- 
chase of the required factors of production. He would be forced 
to discontinue the pursuit of his plans if the credit expansion 
were not to continue. However, as the banks do not stop expand- 
ing credit and providing business with “easy money,” the 
entrepreneurs see no cause to worry. They borrow more and 
more. Prices and wage rates boom. Everybody feels happy and is 
convinced that now finally mankind has overcome forever the 
gloomy state of scarcity and reached everlasting prosperity. 

In fact, all this amazing wealth is fragile, a castle built on the 
sands of illusion. It cannot last. There is no means to substitute 
banknotes and deposits for nonexisting capital goods. Lord 
Keynes, in a poetical mood, asserted that credit expansion has 
performed “the miracle ... of turning a stone into bread .” 1 But 
this miracle, on closer examination, appears no less questionable 
than the tricks of Indian fakirs. 

There are only two alternatives. 

One, the expanding banks may stubbornly cling to their expan- 
sionist policies and never stop providing the money business 
needs in order to go on in spite of the inflationary rise in produc- 
tion costs. They are intent upon satisfying the ever increasing 
demand for credit. The more credit business demands, the more 
it gets. Prices and wage rates sky-rocket. The quantity of bank- 
notes and deposits increases beyond all measure. Finally, the 
public becomes aware of what is happening. People realize that 

l Paper of the British Experts (April 8, 1943). 

198 — The Causes of the Economic Crisis 

there will be no end to the issue of more and more money substi- 
tutes — that prices will consequently rise at an accelerated pace. 
They comprehend that under such a state of affairs it is detrimen- 
tal to keep cash. In order to prevent being victimized by the 
progressing drop in money’s purchasing power, they rush to buy 
commodities, no matter what their prices may be and whether or 
not they need them. They prefer everything else to money. They 
arrange what in 1923 in Germany, when the Reich set the classi- 
cal example for the policy of endless credit expansion, was called 
die Flucht in die Sachwerte, the flight into real values. The whole 
currency system breaks down. Its unit’s purchasing power dwin- 
dles to zero. People resort to barter or to the use of another type 
of foreign or domestic money. The crisis emerges. 

The other alternative is that the banks or the monetary 
authorities become aware of the dangers involved in endless 
credit expansion before the common man does. They stop, of 
their own accord, any further addition to the quantity of bank- 
notes and deposits. They no longer satisfy the business 
applications for additional credits. Then the panic breaks out. 
Interest rates jump to an excessive level, because many firms 
badly need money in order to avoid bankruptcy. Prices drop sud- 
denly, as distressed firms try to obtain cash by throwing 
inventories on the market dirt cheap. Production activities 
shrink, workers are discharged. 

Thus, credit expansion unavoidably results in the economic 
crisis. In either of the two alternatives, the artificial boom is 
doomed. In the long run, it must collapse. The short-run effect, 
the period of prosperity, may last sometimes several years. While 
it lasts, the authorities, the expanding banks and their public rela- 
tions agencies arrogantly defy the warnings of the economists 
and pride themselves on the manifest success of their policies. 
But when the bitter end comes, they wash their hands of it. 

The artificial prosperity cannot last because the lowering of the 
rate of interest, purely technical as it was and not corresponding 
to the real state of the market data, has misled entrepreneurial 
calculations. It has created the illusion that certain projects offer 
the chances of profitability when, in fact, the available supply of 

The Trade Cycle and Credit Expansion — 199 

factors of production was not sufficient for their execution. 
Deluded by false reckoning, businessmen have expanded their 
activities beyond the limits drawn by the state of society’s wealth. 
They have underrated the degree of the scarcity of factors of pro- 
duction and overtaxed their capacity to produce. In short: they 
have squandered scarce capital goods by malinvestment. 

The whole entrepreneurial class is, as it were, in the position 
of a master builder whose task it is to construct a building out of 
a limited supply of building materials. If this man overestimates 
the quantity of the available supply, he drafts a plan for the exe- 
cution of which the means at his disposal are not sufficient. He 
overbuilds the groundwork and the foundations and discovers 
only later, in the progress of the construction, that he lacks the 
material needed for the completion of the structure. This belated 
discovery does not create our master builder’s plight. It merely 
discloses errors committed in the past. It brushes away illusions 
and forces him to face stark reality. 

There is need to stress this point, because the public, always in 
search of a scapegoat, is as a rule ready to blame the monetary 
authorities and the banks for the outbreak of the crisis. They are 
guilty, it is asserted, because in stopping the further expansion of 
credit, they have produced a deflationary pressure on trade. Now, 
the monetary authorities and the banks were certainly responsi- 
ble for the orgies of credit expansion and the resulting boom; 
although public opinion, which always approves such inflation- 
ary ventures wholeheartedly, should not forget that the fault rests 
not alone with others. The crisis is not an outgrowth of the aban- 
donment of the expansionist policy. It is the inextricable and 
unavoidable aftermath of this policy. The question is only 
whether one should continue expansionism until the final col- 
lapse of the whole monetary and credit system or whether one 
should stop at an earlier date. The sooner one stops, the less 
grievous are the damages inflicted and the losses suffered. 

Public opinion is utterly wrong in its appraisal of the phases of 
the trade cycle. The artificial boom is not prosperity, but the 
deceptive appearance of good business. Its illusions lead people 
astray and cause malinvestment and the consumption of unreal 

200 — The Causes of the Economic Crisis 

apparent gains which amount to virtual consumption of capital. 
The depression is the necessary process of readjusting the 
structure of business activities to the real state of the market data, 
i.e., the supply of capital goods and the valuations of the public. 
The depression is thus the first step on the return to normal con- 
ditions, the beginning of recovery and the foundation of real 
prosperity based on the solid production of goods and not on the 
sands of credit expansion. 

Additional credit is sound in the market economy only to the 
extent that it is evoked by an increase in the public’s savings and 
the resulting increase in the amount of commodity credit. Then, 
it is the public’s conduct that provides the means needed for 
additional investment. If the public does not provide these 
means, they cannot be conjured up by the magic of banking 
tricks. The rate of interest, as it is determined on a loan market 
not manipulated by an “easy money” policy, is expressive of the 
people’s readiness to withhold from current consumption a part 
of the income really earned and to devote it to a further expan- 
sion of business. It provides the businessman reliable guidance 
in determining how far he may go in expanding investment, 
what projects are in compliance with the true size of saving and 
capital accumulation and what are not. The policy of artificially 
lowering the rate of interest below its potential market height 
seduces the entrepreneurs to embark upon certain projects of 
which the public does not approve. In the market economy, each 
member of society has his share in determining the amount of 
additional investment. There is no means of fooling the public 
all of the time by tampering with the rate of interest. Sooner or 
later, the public’s disapproval of a policy of over-expansion takes 
effect. Then the airy structure of the artificial prosperity col- 

Interest is not a product of the machinations of rugged 
exploiters. The discount of future goods as against present goods 
is an eternal category of human action and cannot be abolished 
by bureaucratic measures. As long as there are people who prefer 
one apple available today to two apples available in twenty-five 
years, there will be interest. It does not matter whether society is 

The Trade Cycle and Credit Expansion — 201 

organized on the basis of private ownership of the means of pro- 
duction, viz., capitalism, or on the basis of public ownership, viz., 
socialism or communism. For the conduct of affairs by a 
totalitarian government, interest, the different valuation of present 
and of future goods, plays the same role it plays under capitalism. 

Of course, in a socialist economy, the people are deprived of 
any means to make their own value judgments prevail and only 
the government’s value judgments count. A dictator does not 
bother whether or not the masses approve of his decision of how 
much to devote for current consumption and how much for addi- 
tional investment. If the dictator invests more and thus curtails 
the means available for current consumption, the people must 
eat less and hold their tongues. No crisis emerges, because the 
subjects have no opportunity to utter their dissatisfaction. But in 
the market economy, with its economic democracy, the con- 
sumers are supreme. Their buying or abstention from buying 
creates entrepreneurial profit or loss. It is the ultimate yardstick 
of business activities. 

V. The Inevitable Ending 

It is essential to realize that what makes the economic crisis 
emerge is the public’s disapproval of the expansionist ventures 
made possible by the manipulation of the rate of interest. The 
collapse of the house of cards is a manifestation of the democratic 
process of the market. 

It is vain to object that the public favors the policy of cheap 
money. The masses are misled by the assertions of the pseudo- 
experts that cheap money can make them prosperous at no 
expense whatever. They do not realize that investment can be 
expanded only to the extent that more capital is accumulated by 
savings. They are deceived by the fairy tales of monetary cranks 
from John Law down to Major C.H. Douglas. Yet, what counts in 
reality is not fairy tales, but people’s conduct. If men are not pre- 
pared to save more by cutting down their current consumption, 
the means for a substantial expansion of investment are lacking. 

202 — The Causes of the Economic Crisis 

These means cannot be provided by printing banknotes or by 
loans on the bank books. 

In discussing the situation as it developed under the expan- 
sionist pressure on trade created by years of cheap interest rates 
policy, one must be fully aware of the fact that the termination of 
this policy will make visible the havoc it has spread. The incorri- 
gible inflationists will cry out against alleged deflation and will 
advertise again their patent medicine, inflation, rebaptizing it 
re-deflation. 2 What generates the evils is the expansionist policy. 
Its termination only makes the evils visible. This termination 
must at any rate come sooner or later, and the later it comes, the 
more severe are the damages which the artificial boom has 
caused. As things are now, after a long period of artificially low 
interest rates, the question is not how to avoid the hardships of 
the process of recovery altogether, but how to reduce them to a 
minimum. If one does not terminate the expansionist policy in 
time by a return to balanced budgets, by abstaining from govern- 
ment borrowing from the commercial banks and by letting the 
market determine the height of interest rates, one chooses the 
German way of 1923. 

2 [See note on p. 185, note 1.— Ed.] 


Agriculture, 102, 165, 173-74 
American Revolution, 11, 22 
“Anarchy” of production, 155-56 
Apoplithorismosphobia, 60-61, 72 
Aristophanes, 50 

Austria (Austro-Hungarian Empire), 6, 
21, 33, 118-19, 130n, 141, 150n 
money and banking policy of, 66 
Austrian School of economics, 54 
See also Circulation Credit (Mone- 
tary) Theory 
Autarky, 174 

Averages (arithmetical means), in deter- 
mining index numbers, 77-78 

Balance-of-payments, doctrine of foreign 
exchange, 25-31, 44-51 
Banknotes, prohibition against, not cov- 
ered by metal, 39ff. 

Banking policy 

history of, 62-66, 116-23, 132-34, 

“needs of business” doctrine, 103-05, 

See also Free banking; Germany; 
Monetary reform; United States 
Banking School, 42, 44, 54, 66, 103-05, 
122, 130 

Banks, government intervention in, 

Bastiat, Frederic, 133 
Bendixen, Friedrich, 42 
Bills of exchange, xvi, 105 
Bimetallism, 61, 94 
Bohm-Bawerk, Eugen von, 56, 191 
Bourse, 4n 

Business cycles. See Trade cycles 

Business forecasting (speculation), 7-8, 
146-49, 195-96 

Cantillon effect (injection effect), 85ff. 
Capitalism, 35 

Capitalistic (market) production, 34-35, 
155-60, 171-72, 199 
Cassell, Gustav, 72 
Chartism, 58n, 20 

Circulation Credit (Monetary) Theory of 
the Trade Cycle, xvii, 53, 101-15, 
119-26, 132-40, 149-53, 160-63, 
183-85, 189 

Classical economics and value theory, 54 
Classical liberalism. See Fiberals (liberal- 

Coefficient of importance, in computing 
index numbers, 78-79 
Commodity bills. See Bills of exchange 
Commodity money, 62n 
Commodity prices, 172-73 
Consumers, 156-58 
Continentals, 11, 22 
Credit expansion, halting the, 14 
Credit expansion, xix, 104, 162 

course of business cycle and, 85-88, 
105-15, 119, 127-28, 160-62, 

creditor-debtor relations and, 88-93 
crisis and, 113-15, 118n, 127, 155-83 
demand for, 121-23, 125-26, 132-34, 

interest rates and, 107-09, 140-46, 

See also Circulation Credit (Mone- 
tary) Theory; Currency School; 


204 — The Causes of the Economic Crisis 

Credit money, 61, 81 
Credit, commodity versus circulation, 
xix, 104-05, 193-94 
Currency profits and losses, 23 
Currency School, 25-26, 44, 49, 53, 66, 
97-99, 101, 108, 122-23, 126, 
128-29, 132-34, 149-50 

Deficit financing, 35-39 
Deflation (deflationism), xv, 30, 60-61, 72 
as check against demand for foreign 
exchange, 30 

Democracy, economic, 158 
Demonetization, 3 
Douglass, William, 122 

Easy money, 139, 185, 197 
See also Credit expansion 
Economic crisis. See Credit expansion 
Economic measurement. See Index num- 
bers; Statistical studies 
Economic thought 
history of, 53-56 

See also Banking School; Circulation 
Credit (Monetary) Theory; Cur- 
rency School; Quantity Theory 
Empirical studies, 135-36 
England, monetary policy of, 33, 68, 
125-26, 129, 150 
Entrepreneur, role of, 157-60 
Exports, monetary depreciation and, 

Federal Reserve System. See United 

Fiduciary media, 103, 125 
defined, 62 
Final state of rest, 72 
Fisher, Irving, 59, 82ff„ 87-88, 96 
Fisher’s Plan, 59, 82ff„ 87-88, 96 
Flexible standard. See Gold exchange 
(flexible) standard 
Flight to real values. See Inflation 
“Forced savings.” See Savings, “forced” 
Forecasting, 146ff. 

Foreign exchange rates, and war, 21ff. 
Foreign exchange, rate, “final” (“natural” 

or “static”), 24, 26, 31 
rate, explained by balance-of-pay- 
ments, 46 

speculation, 5, 9-12, 14-18, 23-24, 
26-31, 35-36 
France, 117 

Free banking, xvii, 15n, 124-25, 130, 140 
See also Banking policy; Monetary 

French Revolution, and inflation, 11, 22 

money and banking policy of, xv, 3, 5, 
10, 12, 14-17, 21, 22, 31-38, 
40-42, 60, 66, 68, 79, 83-84, 117, 
121, 123 

science and ideology of, 47, 54-55 
Treaty of Versailles and reparations 
and, 5n, 34-38 

value of currency against gold, 16, 23 
Giro banking system, 40 
Gold (coin or “pure”) standard, 2, 18-20, 
20n, 41n, 49-50, 60-61, 67-73, 
93-95, 152 
definition of, 23 
manipulation of, 69ff. 

Gold exchange (flexible) standard, 

18-20, 40, 62-66 

confidence in the new money under, 

Gold outflow (capital flight), 25-26, 

Gold premium policy, 41, 141 

costs and benefits of, 63 
demand for, 62 

supply and production, 18, 19, 60-68, 
72, 96, 134, 176-79 
value of, 67, 71ff. 

Gossen, Hermann Heinrich, 54, 85n 
Government intervention, 169-70 
in international monetary move- 
ments, 25 
Gregory, T.E., 28n 
Gresham’s Faw, 2, 25-26, 50, 94 

Haberler, Gottfried, 76n 
Hansen, Alvin H., 193 

Index — 205 

Harvard Three Market Barometer, 135-37 
Hayek, Friedrich A., xi 
Helfferich, Karl, 34 

Historicism (Historical-Empirical-Realis- 
tic School), 66, 98 
Hoarding, prohibition of, of foreign 
moneys, 30 
Hume, David, 7 
Hungary, 8, 17 

collapse of paper monetary system 
under, 30 
See also Inflation 

Ideology, 146 

influence of, 43-44, 121, 123-27, 131, 
138-39, 174-76, 179-81 
Imaginary construction, 73-76 
Immigration, 170 

Index numbers, 57-60, 77-79, 80-88 

Index standard, 58, 96 


arguments for, xviii, 31-33 
as a kind of a tax, 32 
as creating illusory prosperity, 33 
as a product of human action, 38, 43 
as a psychological aid to economic 
policy, 33, 38 

as a remedy against overly high wage 
rates, 178 

course of, 2-13, 16-18, 44-45, 85-88, 
117-18, 162, 198 
crack-up boom (crisis and panic), 
7-14, 114 

creditor-debtor relations under, 7-9, 
defined, 2n 

disrupts business calculations, 6-8, 33 
“flight to real values,” 8-9, 114, 


foreign exchange and, 36, 45 
international trade and, 21-24, 

25-31, 44-51, 87 
paper money, 117 
shift to foreign money and specie 
under, 10-11 
speculation under, 9-10 
Inflationism, as a lesser evil, 31-32 

Institutionalism, 54 
Interest rates 

demand for lower, 121-23, 160-63 
effects of inflation on, 7-8 
effect of credit expansion on, 7, 

107-08, 142-44, 185-88, 196-202 
gross, 83 

influence of banks and government 
on, 104-05, 136-38, 191-93, 

natural rate versus money rate, 
107-15, 120, 163 

price premium, xv, 82-84, 109-15, 

market (“natural” or “static”), 161, 

International cooperation, 140-42, 152 
Interventionism, xvii-xviii, 127, 180 
See also Government intervention 
Italy, 117 

Jevons, William Stanley, 54, 58n 
Justice, 89 

Keynes, John Maynard, xviii, 59, 96, 152, 
193, 197 

Knapp, Georg Friedrich, 12n 
Kondratieff, N.D., 117n 

Labor, 157-58, 164-69, 178-79, 187, 
195-96. See also Wages; Unemploy- 

Legal tender laws, 1 1 
Lerner, Abba, 193 
Liberals (liberalism), 68, 93-94 
Lowe, Joseph, 58 

Machlup, Fritz, 64n 
Malinvestment, xvi, 109-11, 114-15, 
142, 160-63, 178, 196-201 
Mandats, 11, 22 
Marks, 10 

Marxian doctrines, 100, 155-56 
Measurement. See Index numbers; 

Money; Statistical studies 
Menger, Carl, 54, 76n 

206 — The Causes of the Economic Crisis 

Mercantilism, 48 
neo-, 30 

Modern economy, greater importance of 
money to, 12 

Monetary depreciation (appreciation), 3, 
15, 36, 43, 106, 110, 152 
Monetary manipulation, 57-60, 80-82, 
88-93, 140-46 
See also Gold standard 
Monetary reform, 14-24, 39-44, 

138-40, 149-50, 179-81 
Monetary standard, subsidiary versus 
vassal, 19 

Monetary theory of the trade cycle. See 
Circulation Credit (Monetary) The- 
ory of the Trade Cycle 
Monetary unit 

purchasing power of, xiv, 2-7, 22-24, 
26-31, 68-76, 88-93, 105-07, 
116-17, 133-34 

purchasing power of, measuring, 73ff. 
Monetary value, in the short run, 23 
Money (money substitutes), 57, 61-62, 
103-05, 128 

as standard of deferred payments, 58 
demand for, 2-6, 8-9, 62n, 103 
external exchange value of, In, 76n 
internal objective exchange value of, 
In, 76n 

market, 41-42, 140-45 
“scarcity of,” 7, 42 

shortage of notes of, 6, supply of, 18, 

subjective exchange valuation of, 74 
treated as capital stock, 21 
See also Stabilization of prices; State 
Theory of Money 

Monometallism. See Gold standard; Sil- 
ver standard 

Multiple commodity standard, 58-60, 
81-82, 90 

Natural versus money interest rates. See 
Interest rates 

Necessities versus luxuries, 28 
Needs of business, 103-05, 121-23, 

Nominalism, 54, 58n 

Overproduction theory of the trade 
cycle, 100 

Overstone, Lord Samuel Jones Loyd, 53, 
98, 119, 131 

Paper money. See Credit money 
Parity, between paper and commodity 
moneys, 93 

Peel’s Bank Act (1844), 39, 44, 55, 112n, 
126, 134 
Pessimism, 99 
Poland, 17 

Post office savings institution, 150 
Price level fallacy, 74, 151-52 
See also Index numbers 
Price premium. See Interest rates 
Price supports and subsidies, 172-73 
Prices, 88-93, 155-60, 195-96 
as indices of scarcity, 196 
Producers’ policy, 159-60 
Proudhon, Pierre Jean, 133 
Psychological and intellectual theories of 
the trade cycle, 100-01 
Pump-priming, 184 
Purchasing power parity, 26, 45-46 

Quantity theory of money, 4, 25, 53, 57, 
81, 133 

Rathenau, Walter, 37n 
“Rationalization,” 159, 171 
Re-deflation, 185, 202 
Reparations, war, 34ff. 

Reserves, interest on “idle,” 65ff. 

Ricardo, David, 20, 53, 63 
Romanovs, 8n 
Ropke, Wilhelm, 117n 
Russia, 8n 

Savings, “forced” (“compulsory”), 106, 
111-13, 128, 129 
Schaefer, Carl A., 19n 
Scrope, G. Poulett, 58 
Seipel, Ignaz, 6n 
Seisachtheia, 93 
Silver standard, 61 

Index — 207 

Smith, Adam, 7, 63, 121 
Speculation, 17, 143 
Spencer, Herbert, 148 
Spiethoff, Arthur, xviii 
Stabilization crisis, 118 
Stabilization of prices (monetary value), 
55, 57, 72, 80-91, 97, 151-52, 
172-74, 176-78 

State Theory of Money, 12n, 58n, 69, 79 
Stationary economy, 91, 97 
Statist Theory, 43-44 

See also Government intervention 
Statistical studies, xvi, 73-79, 135-36, 

Stock market, 144-45 
Subjective value theory, 54 
Suess, Eduard, 72 

Tabular standard, 58ff 

See also Multiple commodity stan- 

Taxation, 175-76 

as check against demand for foreign 
exchange, 32-38 

as affecting the entire economy, 32 
public opinion and, 37 
Terminology, 76n, 103n 
Theirs, Louis Adolphe, 1 1 
Time preference, 200 
Tooke, Thomas, 123 

Trade cycle theories, 99-103, 119-21, 

See also Circulation Credit (Mone- 
tary) Theory of the Trade Cycle; 
Credit expansion 
Trade cycles, 56, 97ff. 

Translations, xix 

Underconsumption theory of the trade 
cycle, 100 

Unemployment, 164-72 
Unions, labor, xviii, 166, 187 
United States, agriculture of, 102, 

Federal Reserve System of, 70, 126, 

monetary policy of, 125-26, 150 

Vaihinger, Hans, 74 

Wages, 165 

Walras, Leon, 54, 132 

Weather theory of the trade cycle, 100 

White, Horace, 11 

Wicksell, Knut, 107, 132 

World War I, 69, 86 

Every boom must one day come to an end. 

-Ludwig von Mises (1928) 

Ludwig von Mises, in 1912, was the first economist to discern 
and fully elucidate the cause of the business cycle: the manipula- 
tion of money and credit by the central bank. As founder of the 
Austrian Institute for Business Cycle Research, he was also one of 
the few to see that the monetary machinations of the 1920s would 
lead to global economic calamity. 

Thus did he predict the Great Depression, as his essays from the 
1920s demonstrate. Mises went further to explain what would have 
been the proper course of action, and, later, to recommend funda- 
mental reforms that would end the persistent problem of cyclical 

Because they were so late in being translated to English, these 
essays have been sadly neglected, even in the years after F.A. Hayek 
received the Nobel Prize for his elaboration on the Misesian theory. 
The insights and analytics of The Causes of the Economic Crisis 
therefore constitute a major revelation with profound application in 
our time. 

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